New York Comes to Silicon Valley

Look to recent funding deals for Ning and Slide to see evidence that Wall Street may be cutting out the middleman—venture capitalists

by Sarah Lacy

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The relationship between the venture capitalists of Sand Hill Road and the securities firms and power investors of Wall Street has long been a cozy one. VCs hoping for a return on their investments will need banks eventually, while Wall Street needs VCs to nurture the most promising startups until they're ready to go public.

Or do they?

Lately, some of New York's biggest players have been cherry-picking the best pre-IPO investments for themselves. Marc Andreessen's Ning was recently funded by Legg Mason (LM), T. Rowe Price (TROW), and Ziff Brothers Investments for a valuation of more than $200 million. Max Levchin's Slide got $50 million from Fidelity Investments and T. Rowe Price, conferring a $550 million valuation on the maker of widgets for social networks (BusinessWeek.com, 1/18/08).

Predictably, pundits wrung their hands over sky-high valuations—missing entirely the real cause for alarm among Silicon Valley's blue-shirt-and-khaki set: Wall Street is putting the squeeze on an already troubled VC community.

The VC Squeeze

If you've read anything I've written in the past eight years, you know I think the venture capital industry is in a bad way (BusinessWeek.com, 10/3/07). The calamity comes as ballooning global pension funds seeking better-than-broad market returns meet up with venture capitalists eager to fund the next Bill Gates, Steve Jobs, or Mark Zuckerberg (Facebook's founder)—helping to create an entire asset class out of what probably should have remained a subset of niche investments.

The upshot: Very few firms are making so-called venture-style returns on all that money sloshing around Silicon Valley. Sure, last year's initial-public-offering and acquisition numbers look good in the aggregate, but when you consider the time and money needed to birth all those "successes," there were precious few home runs—and a lot of portfolio losses. Outside the handful of VCs that generate 90% of the industry's returns, a lot of firms are struggling to stay viable.

VC life was already complicated by the so-called angel investors capable of parking big bucks in promising early-stage companies. A lot of hot startups are getting funding early on from angel investors who made their fortunes in the late 1990s. That, along with dramatically lower startup costs, means VCs are forced to buy in when the company is more mature and their funding brings far less ownership, and entrepreneurs are able to retain control in ways rarely seen in the Valley.

And now, thanks to Wall Street, VCs are also getting squeezed at the late-stage end. If even early-stage companies aren't buying the mantra that VCs add value, provide guidance, etc., then surely a later-stage Web company that's already reaching a large, valuable audience won't. And as the Ning and Slide deals show, banks will almost always offer larger valuations—and meddle less.

An Elite Club

For Silicon Valley, the pinch may only worsen, thanks in large part to the efforts of Allen & Co. The New York firm is the expert matchmaker putting together name-brand entrepreneurs with a bank that wants them so bad, it'll seemingly pay any price. Allen & Co. is heavily relationship-oriented, inviting the cream of the high-tech and media crop to its swanky Sun Valley Media Conference every summer. Where else can a young hotshot founder rub shoulders with Gates or News Corp.'s (NWS) Rupert Murdoch?