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The Comeback's Missing Piece

Silicon Valley's Venture Capitalists Need More Than Technological Innovation to Begin Investing Again. They Need Guts.

March 09, 2003|Joseph Menn

Yobie Benjamin has serious tech cred, and it's not just because of his long hair and wonk-square glasses. Two parts Kevin Mitnick and one part Steve Wozniak, the exuberant 43-year-old Philippines immigrant has the requisite hacker--and a certain guru--status since demonstrating five years ago how to breach a financial company's computer system on ABC's "20/20."

But Benjamin also is enjoying a new career as a successful venture capitalist. He went huge during the late-'90s stock-market boom, donning a suit at Ernst & Young and managing more than 200 technology consultants. He taught the Big Three automakers how to buy their supplies online through a joint Web site, and he built up Ernst & Young's portfolio of venture capital investments. By the time Benjamin and two partners launched their own $100-million San Francisco venture fund last year, few people were more qualified to spot winning technology companies in Silicon Valley.

So with all the buzz about cyber-security, nanotechnology and the other Next Big Things of Silicon Valley, where is Benjamin putting his money?

Into dishwashing liquid.

Benjamin's 20-10 Growth Capital Partners' first investment is in Method Home, which is trying to transform the $20-billion household cleaning industry with stylish containers, environmentally friendly products and upscale prices. His fund also is considering stakes in companies that run electronic ad marquees in shopping malls, sell children's clothing and operate barbershops.

Benjamin has some regrets about turning his back on technology. But with venture firms laying off staff and the survivors reducing their tech investments, trying to pick which young companies might provoke the next boom "is an extremely crowded field," he explains. "When you do what everyone else is doing, you lose."

Then he excuses himself to listen to a pitch for a chain of spas.

As much as any empty building or line at the unemployment office, Benjamin's loss of nerve speaks volumes about the state of the Silicon Valley economy. Venture capitalists like him bankrolled the adventures of the past decade, making billions of dollars for themselves and others. The companies they funded created tens of thousands of jobs, and the 1,000 square miles of former farmland between San Jose and San Francisco pushed the global economy so fast that experts spoke of a permanent change in the way the economy works, even the end of capitalism's classic cycles.

The world now knows those experts were wrong. And no one has taken those lessons more to heart than the fast-talking, fast-acting preachers of progress in the valley. A little less hubris and a little more humility were certainly overdue, so it's not a bad thing that fewer truly stupid ideas are getting venture money now. But many entrepreneurs complain that the pendulum has swung too far in the other direction--venture firms like Benjamin's still control billions of dollars, but they're so nervous that they're not investing much of it.

Until they gird their loins and open their wallets again to technology, Silicon Valley will continue to struggle and the U.S. economy will be without one of its most powerful engines. How long that will take is anyone's guess. But just as some old-growth forests need a fire to regenerate, the scorching pain of the recent downturn is a necessary first step to recovery. Many of the precursors for opportunity in the valley already are falling into place.

The most fundamental changes are taking place behind the scenes, in the dynamics of the money that fuels ideas both great and not-so-great. It all started with the fall of the stock market. Without an appetite among public investors, the smorgasbord of initial offerings ended. That meant venture firms couldn't cash out, and it seemed suddenly unwise to keep pouring money into companies that were years from profitability. As the venture firms' progeny disappeared, the 200% returns that many firms had been giving their limited-partner investors went the way of the Netscape browser. The average dollar put into a U.S. venture fund in September 2001 was worth less than 80 cents a year later, according to the National Venture Capital Assn., the first time in at least 20 years that venture investors, as a class, lost money.

The resulting caution has changed almost everything the venture capitalists do. They are investing more in later-stage companies that are closer to profitability, and they are more likely to back companies with proven products. "You can no longer invest in companies that will take $50 million or $100 million to get to break-even," says Ken Lawler of Battery Ventures, which recently let two of its partners go.

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