RED HERRING

How to rate a venture capital firm

By Lawrence Aragon

April 16, 2001

Red Herring explains how it came up with its list of top venture capital firms

for the 2001 version of the Red Herring 100: Kleiner Perkins Caufield and

Byers, Accel Partners, Matrix Partners, Sequoia Capital Partners, and runner-

ups Oak Investment Partners, Mayfield, Greylock, Menlo Ventures, North

Bridge Venture Partners, and Benchmark Capital.

Venture capital is like baseball without the stats. There are great arguments

about who's the best -- and worst -- VC around. But unlike baseball fans, those

who follow venture capital have scant data on which to base their opinions.

Until now.

As part of our annual Red Herring 100, we set out to determine the top ten VC

firms using the best metrics we could come up with. To our knowledge, this is

the first time anyone has come up with a list based on more than a single

metric, such as the internal rate of return (IRR).

Before we get into each of the ten factors we examined, allow us a brief

explanation as to why we didn't include the most common metric: IRR. IRR is

a number determined by each VC firm, and although it's bandied about

frequently, it can be easily tweaked to make a firm look like it's doing better

than it actually is. It isn't uncommon for a VC that isn't performing very well to

inflate its IRR by counting its own "carry," the money it makes from

investments, into its IRR.

The only real way to know how a VC firm is performing is to look at its

disbursements to its limited partners (LPs). This is the actual stock or money

that VCs get from a liquidity event -- that is, a portfolio company's IPO or its

sale to another company. The only problem is, VCs don't want to share this

information.

Enter Steve Lisson, editor of InsiderVC.com, a venture capital research firm.

Mr. Lisson has been able to infiltrate the closemouthed community of LPs and

get its members to share disbursement figures. We asked Mr. Lisson to come

up with a list of the best ten VCs in the country, based on disbursements to LPs

and how consistently they have returned the big bucks to LPs.

Here, then, are the top ten venture capital firms: Kleiner Perkins Caufield &

Byers, Accel Partners, Matrix Partners, Sequoia Capital Partners, Oak

Investment Partners, Mayfield, Greylock, Menlo Ventures, North Bridge

Venture Partners, and Benchmark Capital. The top four firms (the first four

listed) made it into the Red Herring 100. Now, on to our criteria: underneath

the chart just below we review in depth the ten factors we rated the companies

on.

1. Kleiner Perkins Caufield &

Byers 10 10 10 6 10 9 10 5 10 109.09

2.Accel Partners 9 9 8.58 10 9 9 5 10 108.77

3. Matrix Partners 9 10 10 9 5 10 10 10 4 6 8.36

4. Sequoia Capital Partners 6 10 9.5 8 10 7.5 10 5.5 2 4 7.14

(tied) Oak Investment

Partners 8 10 6.5 10 2 5 10 7 2 107.14

(tied) Mayfield 7 10 9.5 7 10 8 10 6 0 4 7.14

7. Greylock 6 10 10 9 4 9 10 7 6 0 7.00

8. Menlo Ventures 8 10 5.5 8 3 10 6.5 7.5 2 2 6.41

9. North Bridge Venture

Partners 7 3.5 10 7 6 9 8 9.5 0 2 6.27

10. Benchmark Capital 7 3 6.5 7 3 8 1 4 10 2 5.32

Average7.7 8.55 8.6 7.9 6.3 8.45 8.45 6.65 4.6 5 7.26

1 The disbursement category is weighted twice that of other categories. Data from Steve Lisson,

editor of InsiderVC.com.

2 Operating experience counts VP level and above.

Disbursements.

Mr. Lisson gave a score of 10 to just one VC firm: Kleiner Perkins Caufield &

Byers. Benchmark Capital, which has had some monster hits in the past couple

of years, scored a 7, because it has only been around for six years.

Longevity.

In the venture business, age counts for a lot. It means a firm has been battle-

tested and has done well enough to get its LPs to continue investing. We took

each firm's number of years in business and divided that figure in half to come

up with a score (with a maximum score of 10). Six firms earned a 10. Two firms

came up short: Benchmark and North Bridge Venture Partners, with scores of

3 and 3.5, respectively.

Pressure to invest.

A general partner is better off if there isn't pressure to put a lot of money to

work. We divided the amount of a firm's current fund size by its number of

general partners, then assigned a value to the resulting figure. After talking to

several VCs, we determined that $90 million per partner was reasonable to

assign a score of 10. We gave a 9 to anyone managing $110 million, an 8 to

those managing $130 million, and so on.

VC experience.

This should be self-explanatory as to why it's important. We gave general

partners with 15 years or more of experience a score of 10. Those with 12 to 14

years received a 9, and so forth. Oak Investment Partners came out on top in

this category, with an average of 17 years for its partners. Even though Kleiner

has at least three partners with more than 20 years of experience, its score got

knocked down to a 7 because it recently added some technology executives to

its partnership.

Operating experience.

With so many portfolio companies in trouble these days, every VC firm needs

partners who've been in the real world to advise troubled companies. We gave

each firm a point for any general partner with operating experience, plus a

bonus point for any partner who qualified as a "star." General partners who fell

into the star category include Kleiner's Ray Lane, former president and chief

operating officer (some say the de facto CEO) of Oracle, and Mayfield's Janice

Roberts, who ran Palm when it was a division of 3Com.

Board seats.

Six boards is the maximum number you can sit on and still actually contribute

valuable time and energy, we're told by veteran VCs. Menlo Ventures and

Matrix Partners were the only firms whose partners sat on an average of six or

fewer boards, giving them perfect 10s. We gave firms whose partners held an

average of seven to eight board seats a score of 9, and so on. Oak fared the

worst: its six general partners sit on an average of 12 boards each.

IPOs/Sales.

This is one of those categories that VCs like to brag about, but it can often be

misleading. Two firms may be in the same IPO, but one may own 15 percent of

a company while another owns 1 percent. The only real way to know how well a

VC did in an IPO is through disbursement figures. Still, we felt we should give

VCs some credit for liquidity events. We gave a firm one point for every $1

billion in value, with a maximum of 10 points for $10 billion. IPO figures were

based on the close on the first day of trading. Sale prices were based on the

value on the day the deal closed. A lot of moonshot IPOs have fallen back to

earth, so this category is squishy at best.

Lack of portfolio problems.

Matrix was the only firm on our list that had no failed or troubled companies.

We gave each firm 1 point for every failed company and half a point for every

company that had laid off employees in the past year. We then subtracted that

total from 10. Benchmark fared the worst in this category with a score of 4.

Blame it on those Internet bets like Living.com, MVP.com, and Send.com.

RH 100 factor (2000 and 2001).

VCs deserve credit for portfolio companies that show great promise. Because

the staff of Red Herring spent weeks vetting all of the companies that made the

Red Herring 100 list, we used the private portion of the list (50 companies) in

2000 and 2001 as a basis for determining potential hits. For every portfolio

company on the Red Herring 100, we gave a firm 2 points, with a maximum of

10. Kleiner and Accel Partners were the only firms to receive 10s for both years.

Kleiner had the most companies on this year's list: Zaplet, Epoch, Synaptics,

SmartPipes, Asera, and Bowstreet.

As much time as we spent thinking about how to create a top ten VC list, and

then double- and triple-checking the data, we'd be nave if we didn't expect

some VCs to take issue with our numbers or our methodology. So, don't feel

shy about expressing your opinion.

Write to laragon@redherring.com.

Note: In the "Top 10 VC Firms" on page 185 of issue 97, Menlo Ventures

should have been ranked No. 8 and North Bridge Ventures should have been

No. 9. In addition, we did not make it clear that three firms tied for 4th place:

Sequoia Capital Partners, Oak Investment Partners, and Mayfield. The data

is correct here.

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FORTUNE

Steve Lisson, Stephen N. Lisson

VALLEY TALK

Behind the VC Music

FORTUNE

By Mark Gimein

Stephen Lisson is not a conventionally likable guy. On more

than one occasion, he's implied that I'm the single stupidest

reporter he's ever talked to. He has kept me on the phone for

hours at a time listening to the most arcane statistics, until I've

slammed down the phone in frustration. He calls people who

disagree with him "lickspittles." He dismisses many of the

visitors to his Website as "parasites."

And yet over the past few months I have repeatedly gone back to

Lisson and his new Website, InsiderVC.com, because Lisson has

the best data out there about venture capital, and often the most

interesting things to say about it.

Venture capitalists are the rock stars du jour of the financial

world, a species of money managers who are believed capable of

superhuman wisdom. Business magazines tend to assume that

the richer you are, the smarter you must be, and the Internet

boom has lavished untold riches on the venture capitalists who

invested early.

"Untold" is a key word here, because hardly anyone knows

exactly how great these riches are. In this way, venture-capital

funds are very different from, say, mutual funds. Venture

capitalists talk vaguely about "triple-digit returns," but even

successful funds tend to keep their returns a closely guarded

secret. And even when they do reveal numbers, they can be hard

to understand.

This is where Austin, Texas, entrepreneur and venture-capital

gadfly Stephen Lisson comes in. Through years of research and,

apparently, a lot of cooperation from a network of sources

willing to send him copies of the reports that venture-capital

firms send out to their investors, Lisson has gathered an

immense database of information about venture-capital firms'

investments and profits.

Lisson doesn't make all his data public--much of his information

is limited to subscribers, and he can be picky even about whom

he allows to subscribe. But what he's already revealed in the

public sections (for example, see: Database Example) of

InsiderVC.com is fascinating. Some of his data shows exactly

what you might expect. Benchmark Capital Partners' 1995 fund-the

fund that famously invested in eBay--has already returned to

its investors 38 times the money they put in. Investors who put

money into the fund that Kleiner Perkins Caufield & Byers,

Silicon Valley's best-known venture-capital firm, raised in 1996,

have already made a similarly spectacular return of over 1,000%.

But you'll also find that the 1997 fund raised by Hummer

Winblad, another venture-capital firm that has traditionally

received a lot of attention from the press, has so far returned

only 42% of its investors' money. That might be a decent

showing in any other era, but in the middle of the biggest

technology boom or bubble in history, it's not great, and not

nearly as good as some of Hummer Winblad's peers. (Typically,

venture funds distribute cash or stocks as the companies in their

portfolio are sold or go public. In theory, that means they can

continue paying out money to investors for a very long time, but

in practice, almost all of their profits are made in the first six

years of the fund.)

Even more interesting are the data that Lisson has gathered on

how venture capitalists value their investments. Venture

capitalists measure their own performance by an "internal rate of

return"--an annualized rate of increase in the value of their

investments. Often that'll be a number in the high double digits,

sometimes in the triple digits. Sounds pretty good when you

compare it with the typical mutual fund. But if you look at the

InsiderVC.com database, you'll find that funds claiming

immense annual returns sometimes pay out a lot less money to

investors than you'd imagine.

As of March 2000, Benchmark claimed an annualized return of

an amazing 279% for Benchmark III, the fund that the firm

raised in 1998. But wait a second! Lisson's data also show that

Benchmark III hadn't actually distributed any cash or stock to its

investors. That 279% return was based on a guesstimate of the

value of the companies Benchmark has invested in--companies

that, since they hadn't gone public, are notoriously hard to value.

One of those companies, Living.com, has already gone bankrupt,

reducing the value of Benchmark's investment from an estimated

$74 million to zero. And it's hard to believe that, with the Net

bubble bursting, Benchmark's investment in eBags.com is really

worth the $20 million-plus that Benchmark valued it at in

March.

For individual investors who don't have a prayer of putting their

money into funds that deal only with tech insiders, large

institutions, and foundations, analyzing exactly how much the

top funds make can certainly seem like an academic exercise. It

can all sound arcane, confusing, and dull, and if you are not an

investor in venture-capital funds, I don't recommend it as a

hobby or a business. But it's important that somebody do it.

First, because venture investment is the engine driving much of

Silicon Valley's technological innovation. And, second, because

it's important for somebody like Lisson to remind investors and

the business press that venture capitalists are not the gods of

finance they are often made out to be, but instead, very well-

trained money managers. Sometimes very smart money

managers, sometimes very lucky money managers, but

nonetheless, financiers who'll often make a lot of money and

sometimes, like the rest of us, flub it.

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