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Still The Benchmark To Bet On?


Information Technology: Venture Capital

Still the Benchmark to Bet On?

It may have been the best six months any investment firm ever had. On June 27, 1997, a little-known venture-capital firm called Benchmark Capital invested $5 million in eBay Inc., a fledgling Internet auction site. Through the rest of 1997, Benchmark took stakes in six other startups, including software insurgent Ariba and online grocer Webvan Group. By last year, when many of Benchmark's companies started going public, the tech world stood amazed at the firm's Midas touch. Benchmark's eBay stake, for example, ended up worth $4.2 billion. Overall, the upstart firm turned its first $85 million investment fund into about $7.8 billion--a jaw-dropping ninety-twofold increase. "The very best funds in the business do 20 [times] or so," says James W. Breyer, a partner at rival Accel Partners. "Anything over 10 is extraordinary."

These days, however, Benchmark is looking much more ordinary. After its scorching start, the firm has seen several of its investments turn into high-profile clunkers. Flower-and-gift site 1-800-Flowers.com Inc. has been pummeled so badly that Benchmark acknowledges its $36 million investment is now worth about $20 million. The online pharmacy PlanetRx.com Inc. teetered on the edge of bankruptcy before announcing a $50 million equity infusion on July 25. Shares of Webvan, Net lender E-Loan, and online jeweler Ashford.com have tumbled by more than 80% from their peaks--and are worth even less than what the last round of private investors paid for their shares before the companies went public.NEARSIGHTED. Just as damaging, Benchmark largely missed the hottest trend in this year's initial public offering market--optical networking. The soaring IPOs of optical-gear companies such as ONI Systems Corp. have brought enormous riches to rival venture firms, notably Kleiner Perkins Caufield & Byers, that began investing in such companies in 1997 and 1998. Benchmark, in contrast, didn't start putting money into optics until last fall. That's a big reason the firm has had only two IPOs in 2000, compared with 15 last year.

Certainly, this is all quite a comedown for a firm so recently considered the hottest in the country. Last year, Benchmark was the industry's prodigy. Although it had just been founded in 1995, its only real peers appeared to be longtime venture titans such as Kleiner Perkins and Sequoia Capital. And Benchmark's partners weren't satisfied with that: They proclaimed that they expected to be the best venture firm in the industry. Now pundits are openly questioning how good the firm is. "When you look at Benchmark, you have to ask whether it's tailwind or talent [that made the firm successful]," says Jesse Reyes, vice-president of Venture Economics, a VC research firm.

Rivals have an even more pointed criticism. They argue that Benchmark's missteps betray a fundamental problem: Its partners tend to pay too little attention to hardcore technology. They point out that Benchmark continued to pour money into simple-to-understand e-tailing ventures, such as the sporting-goods site MVP.com, even after other VCs began to realize that the field was growing overcrowded. At the same time, they didn't seem to grasp the significance of key technology trends, like the move to optical communications gear. "Benchmark really has nothing on the technical side," says Mark D. Kvamme, a partner at Sequoia Capital.

If only. Competitors may wish that Benchmark's early success was simply beginner's luck. But that just isn't the case. A close look at Benchmark's investments, as well as interviews with the firm's investors, suggest that Benchmark is going to remain among the top venture firms for the foreseeable future. Sure, some of its deals are turning out to be losers and its most troubled fund, Benchmark III, may only have average returns because it invested heavily in online retailing. But after the firm's spectacular start, it has the brand-name recognition to attract the hottest deals. And institutions are impressed enough that they have no doubt they'll continue to invest their money there. "We'll be there [in future Benchmark funds] even if the recent funds don't turn out as strong," says Elizabeth Obershaw, chief investment officer for Hewlett-Packard Co. in Palo Alto, Calif., which has put money into all four Benchmark funds.WINNING STREAK. Most investors aren't fretting over Benchmark's technical focus. After all, it has a stellar string of software deals. Thanks largely to the expertise of partner Kevin Harvey, the firm has had sniper-like accuracy in picking winner after winner, turning $10 million in capital into $2.2 billion so far. And Benchmark is taking steps to remedy its lack of experience in other areas. Earlier this year, the firm brought in Alex Balkanski, the former chief executive of chipmaker C-Cube Microsystems Inc., as a partner to beef up its semiconductor and networking expertise. Benchmark also paid $25 million for a 40% stake in Raza Foundries Inc., an incubator that invests in new optical-networking companies. "Maybe they missed optical, but they're smart enough to get it right next year," says Obershaw.

Still, Benchmark has a lot to prove before it can reach its self-proclaimed goal of being the venture industry's top dog. The biggest question: whether Benchmark has the best investment approach. Established venture powerhouses such as Kleiner Perkins try to anticipate where the technology industry is going and bet on technology trends. Benchmark takes the opposite tack. It backs hotshot entrepreneurs it believes in. "We're probably the most tactical group you're going to come across, as opposed to strategic," says general partner Andy S. Rachleff. "We follow great entrepreneurs, and sometimes they lead us to interesting things." That approach worked like a charm in the early days, but it led to mistakes last year as Benchmark backed execs who wanted to start e-tailing sites in niches such as furniture and art.

The true test for Benchmark will come in the next couple years as it invests its latest fund. While the firm collected just $85 million from investors for its first fund, its most recent one, Benchmark IV, is $1 billion. Putting 12 times as much money to work with only seven U.S. partners won't be easy. In the past, Benchmark's partners typically invested $5 million or less into each startup very early on in their development. The challenge going forward is that the firm will have to increase the size of its investments. That will slash the potential for outsize returns and limit its ability to share the risks of deals with other VCs. Already, Benchmark's investments are creeping up in size: Its Benchmark IV deals include a $20 million bet on the online bank Juniper Financial Corp., $30 million for telephone-commerce startup Tellme Networks Inc., and $18 million for MVP.com, the sporting-goods site that counts Michael Jordan, Wayne Gretzky, and John Elway as investors and directors.LOYALTY. Benchmark's partners have no doubt they're up to the challenge. They suspect they're drawing fire now because of jealous competitors. "We could stand on our heads and spit wooden nickels right now, and no one would give us credit," says partner Dave Beirne. And they haven't backed off an inch from their goal of becoming the best venture firm anywhere. "Our objective was to be the recognized leader in venture capital in a 10-year span, and we're on plan," says general partner and co-founder Robert C. Kagle. "It's a marathon, not a sprint."

The striking thing about Benchmark in the summer of the Internet shakeout is not how much it has changed but how little. Relatively small, with only seven investing partners, its point of pride has always been an intimate, egalitarian culture. Its investing partners all take an equal share of the firm's profits. There are none of the junior partners or associates that other firms have. And from the start, its mission was to make money by giving entrepreneurs a supportive environment and experienced counsel.

When it works, it works brilliantly. Several of Benchmark's biggest scores came from companies founded by people who were once entrepreneurs-in-residence at Benchmark--a program in which the firm provides promising would-be CEOs with money and a place to work so they can think up ideas. Among the companies hatched by resident entrepreneurs: Ariba Inc. and Scient Corp., which netted Benchmark $1.2 billion and $625 million, respectively.

The entrepreneur-coddling culture also helps attract top talent. Karl Jacob, a well-respected former Microsoft Corp. exec, chose to take money from Benchmark to start up the pay-for-advice site Keen.com because of the partners' loyalty to entrepreneurs. "They stick with companies through thick and thin, and I've been in the Valley long enough to know how incredibly rare that is," he says. Richard W. Vague, the founder of credit-card powerhouse First USA, went to Benchmark in January to get $20 million for his online bank Juniper Financial because it was the only firm that spent time asking him about his motivation for starting over after selling First USA to Bank One. Netscape Communications co-founder Marc Andreessen also went to Benchmark for funding for his new firm, Web services provider Loudcloud.

But the star system is a key reason Benchmark missed much of the optical-equipment boom over the past year. Benchmark recruited ex-Federal Communications Commission Chairman Reed E. Hundt as an adviser, and he helped convince the firm that telecommunications deregulation was a more promising avenue than the next wave of gear. The thinking was that service companies had a better shot at staying independent than equipment makers. Big mistake: Communications equipment has proved one of the most lucrative markets in all of technology. While Benchmark sat on the sidelines, Kleiner Perkins partner Vinod Khosla correctly anticipated the development, and his firm has made about $6.5 billion in the optical companies ONI, Siara, Corvis, and Cerent.

Benchmark's Kagle concedes that the firm was "underresourced" in communications equipment. But Rachleff points out that Hundt's ideas were sound. For example, Benchmark put $12 million into Equinix Inc., a Redwood City (Calif.) operator of high-security Web hosting centers where telecom providers share space to allow faster, easier exchanges of traffic. The company has filed for an IPO that would make Benchmark's stake worth about $160 million. Benchmark also has high hopes for CoreExpress Inc., a provider of network-management tools that counts Hundt and Rachleff as directors. A home run on CoreExpress could easily make up for strikeouts on e-tailers in the firm's laggard Benchmark III. "Venture capital is a slugging percentage business," says Gurley.MISSTEPS. In the end, that's why Benchmark's missteps almost certainly won't keep it from raising more money in the future. After all, one eBay that turns into more than $4 billion wipes out any number of $5 million investments that disappear. John G. Morris, a vice-president at HarbourVest Partners in Boston, which chooses venture funds for institutions, says venture capital is a very attractive investment compared to such alternatives as putting money into publicly traded stocks. "If you cut their returns in half, it's still extraordinary," Morris says. "Cut them in half again, and they're excellent. Do it again, and they're still pretty good."

Still, pretty good isn't the goal for a young firm that had the audacity to name itself Benchmark. The firm's stumbles show that even smart venture investors can fall for the hype of a favored sector such as online retailing. While those missteps are hardly fatal, they could stop Benchmark from becoming the recognized leader in venture capital anytime soon.By Timothy J. Mullaney in Menlo Park, Calif.Return to top


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