As Venture Capital Business Changes, Elite Firms Move to Keep Their Edge

For the Silicon Valley cognoscenti, the news last week that Mary Meeker, the stock analyst once dubbed “the Queen of the Net,” was abandoning Morgan Stanley to join the Kleiner Perkins venture capital firm seemed about a decade overdue.

But the timing actually underscores some big changes in the venture capital business, and the increasing pressure that even marquee names like Kleiner Perkins Caufield & Byers face in a business that has always been tougher than it looks.

You wouldn’t know it from all the buzz surrounding the new wave of social media and mobile start-ups, but the total dollars invested in venture deals is just a fraction of what it was during the Web 1.0 frenzy — down, even, from 2008 levels.

Meanwhile, a new breed of “superangels,” many of them entrepreneurs who made large fortunes at venture-backed companies, is impinging on traditional venture capital turf. Plus, the global nature of the Internet business means that Silicon Valley venture capitalists, who once held that you should invest only in companies you can visit by car, now face a broader, more complicated playing field. (One of Ms. Meeker’s assets is deep knowledge of China.)

Against this backdrop, the winner-take-all dynamics of the Internet business, and the fact that venture sectors like clean tech and life sciences are struggling, mean that if a prestige venture capital firm misses out on too many of the big Internet deals, it hurts. Kleiner Perkins, notably, was not involved in Facebook, Twitter or Groupon (though it does have a piece of Zynga). Kleiner is now said to be desperate to play a lead role in a what’s expected to be a huge new financing round for Twitter.

For Silicon Valley Internet entrepreneurs, the changing dynamics of the venture capital finance business are not a bad thing. Starting an Internet company these days usually requires much less capital than in the past. The emergence of the superangels, combined with venture capitalists’ hunger for early-stage deals, means better terms for company founders.

For big, successful start-ups, these are also good times, in that the large venture capital firms are moving upstream into what would once have been considered private equity territory, with financing rounds in the nine figures. That gives companies like Twitter and Facebook a lot of options other than going public.

But for many rank-and-file venture capitalists, life is not so good. The institutional investors that are the backbone of venture capital finance — pension funds, insurance companies and university endowments — have generally seen poor returns on these investments over the past decade. That means it’s hard for venture capitalists to raise money.

The industry as a whole is shrinking: the number of venture capital firms in the United States has declined from a peak of 1,023 in the mid-2000s to 794 today, according to the National Venture Capital Association. The amount of money under venture capital management has declined even more. Meanwhile, local venture capitalists are facing new international competitors like DST out of Russia as well as shrewd, Internet-centric domestic rivals like Union Square Ventures, of New York, and Foundry Group, of Boulder, Colo.

At the elite end of the business, though, there is still plenty of clover on Sand Hill Road. A big name like Marc Andreessen, the Netscape co-founder who has shown as good a touch for investing as he did for software development, can raise a fund of $650 million, as he and his partner, Ben Horowitz, just did, without much trouble.

The longtime Valley kingpins — Kleiner, Sequoia Capital, Accel Partners — can aspire both to dominate the glamour deals and to cherry-pick among smaller opportunities, though they can’t rest on their laurels. Kleiner has started special funds for iPhone apps and social media deals.

Indeed, even John Doerr — the Kleiner partner whom Fred Wilson of Union Square Ventures called “the Michael Jordan of venture capital” in a joint appearance at the Web 2.0 conference — has to be very aggressive in this climate.

And that brings us back to Mr. Doerr’s friend, Mary Meeker. Whether she will be a good venture capitalist remains an open question. But she has already added some sizzle for Kleiner, helping solidify its position on the very short A-list of firms that almost any sensible entrepreneur would want in a deal.

In this case, what’s good for Kleiner is good for Silicon Valley.

http://www.nytimes.com/2010/12/05/us/05bcweber.html?_r=1&partner=rssnyt&emc=rss