Rumors of Benchmark's Demise Greatly Exaggerated
For
weeks, rumors have been circulating in the VC community that Benchmark
Capital's third fund, Benchmark III, was in trouble, hit hard by losses
in e-commerce companies like 1-800-Flowers.com.
Benchmark
denies the rumors, and its limited partners say they never received the
rumored letter that the fund was in trouble. An analysis of Benchmark's
portfolio appears to back up the firm, which despite the rumors, may not
just be surviving, but thriving.
Benchmark declined to discuss
details, but the firm's holdings as of June 30 were provided by Steve
Lisson, the editor of InsiderVC.com, who tracks the performance of
leading venture firms for high-paying clients.
At first glance,
Benchmark III had its share of overvalued B2C e-commerce firms like
1-800-Flowers.com (Nasdaq:FLWS) and Living.com. 1-800-Flowers.com was
the fund's biggest investment, at $18.9 million, and had been marked
down to $8.1 million on June 30. The stock price has declined about 30%
since then. "There are many private scenarios just like this public one,
whereby even if the company can be kept afloat long enough to enjoy
some success and eventually make it to a liquidity event, the venture
investors will lose money," Lisson said.
But a closer look at
Benchmark III reveals a fund with several potential winners, including
Internet Data Exchange System company CoreExpress, an intelligent
optical networking play. That investment alone could return limited
partners' money. Other potential winners include Sigma Networks,
Keen.com, Netigy and BridgeSpan.
And Benchmark's newest fund,
Benchmark IV, is already showing the markings of a winner, thanks to
investments in Loudcloud, Netscape co-founder Marc Andreessen's latest
venture, and TellMe Networks, whose valuation no doubt went up in its
recent $125 million funding round.
Lisson said the Benchmark
rumors reflect a misunderstanding of how venture funds operate. "There's
a reason these are 10-year funds," he said. "It's called risk and
illiquidity. The one monster hit could happen three, four or five years
out. You can be wrong about 39 of 40 companies, and the market
uncooperative, as long as one is an Inktomi. That is the history of this
industry: one monster hit returning the entire fund. Singles and
doubles won't get you there."
At two years of age, Benchmark III
still has plenty of time to deliver a big winner. In the meantime, the
firm's limited partners can enjoy the returns from Benchmark II, a
three-year-old fund that has already distributed five times its partners
capital, by Lisson's estimate. Benchmark II boasted big winners like
Handspring (Nasdaq:HAND), Critical Path (Nasdaq:CPTH), Red Hat
(Nasdaq:RHAT), and Scient (Nasdaq:SCNT). Yes, Scient. Benchmark had the
foresight to distribute shares of the Internet consultant to its limited
partners at 200-300 times the firm's cost.
Benchmark isn't any
different from other venture firms, most of whom "drank the Kool-aid" of
seemingly easy dot-com money, hoping the stock market would hold up
long enough to vindicate those investments. But Lisson expects that some
other firms won't hold up as well. He expects a shakeout in the
industry similar to the one that hit the industry from 1987-1991, when
venture firms formed during the 1980s averaged single-digit returns, and
roughly 20% of new entrants couldn't return their partners' capital.
VCs' own fundraising declined from $4.2 billion in 1987 to $1.3 billion
in 1991. The $4 billion level of capital coming into the industry wasn't
reached again until 1995.
"This is what's supposed to happen in a
downturn," Lisson said. "People who shouldn't be in the business, who
contributed to the excesses and didn't know what they were doing, will
be forced out. It's not like this is the first time we've seen too many
new entrants into the industry, or too much money chasing too few
deals." And the ones that survive will have a chance to prove themselves
in tough times, the ultimate mark of a winner.
Lisson said a few
venture firms stand out among their peers. Matrix Partners, Kleiner
Perkins Caufield & Byers and Sequoia can normally be found at the
top of the charts in each vintage year they raise a fund, he said,
proving that "something's in the water" at those firms. And he gives Oak
high marks for consistency over a long period of time.
But even
top firms have an occasional weak fund, Lisson said. "But by the time
you can make that judgment about a fund, you'll have raised another fund
and shown some early progress," he said. Meaning that even if Benchmark
III was a weak fund, Benchmark IV could keep the firm in its limited
partners' good graces for some time to come.
"The moral is
consistent performance over time relative to same vintage-year peers,"
Lisson said. "You're never as good or as bad as your current press
clippings might indicate. The real test of Benchmark's mettle will come
when we can fairly evaluate whether the firm manages through and makes
money, not just with small funds during the best times in the industry's
history, but with larger funds in the tough times ahead as well."
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