From Boom…

By Chris Gaither, Globe Staff, Pg. D11

MENLO PARK, Calif. – Once a year during the height of the Internet run-up, venture capitalists would nestle into custom built soapbox derby cars here and zip down Sand Hill Road, which is to their industry what Wall Street is to banking.

The annual Sand Hill Challenge, started as a lark by a local restaurateur in 1997, raised hundreds of thousands of dollars for local charities. But more important to the participants, the event gave very rich men a great excuse to spend money in pursuit of besting their peers from rival venture capital firms.

The event reflected the heady exuberance of the times. Firms and the companies they did business with recruited industrial designers to build their racers. Ringers were brought in to push the cars – former San Francisco 49ers football star Roger Craig, a world champion soapbox derby racer, even a US Olympic bobsled team. But just like some of the more unfortunate derby cars, the economy crashed. With its organizers unable to raise the $75,000 in sponsorship fees, this June the Sand Hill Challenge perished alongside so many of the misguided start-ups the firms had funded.

Now, there is a new Sand Hill challenge: trying guide portfolio companies through the worst environment for start-ups in decades.

Venture firms pumped $1.97 billion into Silicon Valley companies during the second quarter, leading the nation with 34.6 percent of the total US funding, according to the MoneyTree Survey, prepared exclusively for The Boston Globe by PricewaterhouseCoopers, Venture Economics, and the National Venture Capital Association. Funding here fell a crushing 46 percent from the same period last year and 5 percent from the first three months of this year, though it declined less than the national average.
Venture capitalists are optimists by trade – their job is to see business opportunities where others don’t. In interviews on Sand Hill Road last week, partners from several firms discussed how economic slumps have produced some of the most successful high-tech companies; how valuations are better than ever; how talented engineers looking for work are plentiful; and how the shakeout has sent the “quick-buck artists” home from Silicon Valley, leaving only the most dedicated entrepreneurs and venture capitalists to drive the next wave of innovation.

“I tell my portfolio companies, if you can survive these times and come out a market leader, you win big,” said David J. Ladd, a general partner with Mayfield Fund, a prominent Sand Hill Road firm.

But in private, venture capitalists acknowledge that the sharp downturn has stung badly. Younger partners are losing their jobs as firms pare back their funds or fail to raise new funds. While firms such as Mayfield, US Venture Partners, and New Enterprise Associates have used the downturn to find bargains, many firms have scaled back drastically on new deals. And while some partners are working harder than ever to scrounge up worthwhile investments, many partners have chosen to largely sit out the last year, managing their portfolio companies and playing more golf.

“The mood is one of depression, puzzlement, apathy, and hard work,” said Craig Johnson, chairman of Venture Law Group, a Sand Hill Road-based law firm specializing in start-ups, initial public offerings, and mergers and acquisitions. “It’s a game of survival at this point.”

And in a potentially bad sign for high-tech companies in New England, venture capitalists here say they are much less likely to travel far outside of Silicon Valley to find deals than they were during the boom. Only an extraordinary opportunity and a partnership with a local venture capital firm would entice Ladd to invest in a Northeast company, he said.

Silicon Valley was crawling with venture capitalists when Rob Coneybeer first started with New Enterprise Associates on Sand Hill Road in 1996. An engineer by training, the rookie venture capitalist began hunting for deals in the Boston area, where the Net bubble was slower to inflate. He found success there with such companies as Chelmsford-based Astral Point Communications, which sold to Alcatel for $135 million in stock. He still sits on the board of Coriolis Networks Inc. in Boxborough.

Now Coneybeer is staying closer to home. After averaging two investments a year, he has refrained from any deals in the last year, but he is sniffing around companies he says excite him more than any others in the last 18 months. “The tourists have left the business, and there’s hope again,” he said.

But many venture capitalists have left the business as well. Some are content to cash in and sit out the downturn; others were forced out of downsizing firms. Mayfield, for example, has seven general partners and two associates, down from 10 general partners and four associates at its peak.

Phil Sanderson, a general partner with San Francisco-based WaldenVC, said fewer partners are attending meetings of the Venture Capital Network and the Young Venture Capital Association because partners are being laid off and firms are more reluctant to pay membership dues. “That’s a trend I think we’re just at the beginning of,” he said.

At their retreats during the boom, the seven general partners of Foundation Capital, a firm located a few blocks from Sand Hill Road, debated whether they should hire partners and staffers. In the end, they decided to stay the course. Though he admits feeling “a little like dinosaurs for a while,” Paul Koontz, a general partner, says he is glad now that the firm chose the more conservative path. “Across the industry, everyone is beginning to stick their heads out of the bunker and see what it’s like out there again,” he said.

The demands they place on entrepreneurs are much different now, too, with a focus on cash conservation and customers instead of growth potential. But the institutional investors and other limited partners who provide money to venture capital funds are placing similar demands on the partners who manage their money.

“It’s no longer, ‘Here’s a check, I hope everything goes well,’ ” said Matthew J. Cherry, president of Intelex Ltd., a Greenwich, Conn., firm that performs due diligence for investors. “You’re starting to see limited partners take a more active role before they give the money. That certainly has to give the general partners pause.”

Waltham’s Charles River Ventures is one of the firms that has given money back to its limited partners, cutting its $1.2 billion fund by 63 percent, to $450 million. But at its Sand Hill Road offices last week, general partner Bill Tai offered a positive excuse for arriving 25 minutes late for an interview: He was in a meeting with a start-up whose business plan was so intriguing that he was strongly considering offering it a term sheet.

In a sign that level-headedness has returned to the industry, Tai said he could afford to wait longer than 24 hours without fearing another venture capital firm would beat him to a deal with the start-up. “We’re back to the way it was the other 99 years of the century,” he said. “I love that.”

With the days of whirlwind investments, 30 percent returns, and Sand Hill Challenge races long behind them, venture capitalists are having to reset their expectations. But ever the optimists, they know that reputations are built during times like these.

“It’s definitely not as fun as it was, but it was too easy then,” said Sanderson of WaldenVC. “Things were just handed to you. Now it’s more of a business.”