Mark Zuckerberg was the big one that got away.
Boston venture capitalists declined to fund the founder of Facebook, the world’s most-popular social networking service, when he sought money to expand his startup in 2004. Zuckerberg’s move that year to Palo Alto, California, from his Harvard University dorm was a wakeup call for New England firms, which have lost market share to Silicon Valley and New York in the past seven years, says Michael Greeley, a general partner at Flybridge Capital Partners.
“There was a little bit of shock that we missed it, as a community,” Greeley, a board member of the National Venture Capital Association, said in an interview. Since then, Boston “really rallied around ‘how do you let these kids know that the state is open for business and a great place to start companies?’ Sort of a post-Facebook echo boom effect. Zuckerberg should never have left.”
Greeley’s firm in 2009 started Stay in MA, one of several programs designed to entice young entrepreneurs to stay in the region. Incubators such as Dogpatch Labs, started by Polaris Venture Partners, and TechStars Boston offer free space to aspiring entrepreneurs, and angel investors are scouting campuses in search of the next Zuckerberg, Greeley said. Firms that had moved to the suburban venture capital centers are returning to the city to be closer to the universities.
Boston, the birthplace of modern venture capitalism, accounted for 11 percent of U.S. venture investments last year, down from 15 percent in 2003. Silicon Valley firms increased their share to 39 percent from 34 percent in the same period. Valley firms raised almost three times as much money as their New England counterparts in the past five years, and almost seven times as much in the first quarter of this year.
As a result, Boston missed out on much of the recent surge in initial public offerings, which was driven in part by Internet startups. Of $6.83 billion in venture-backed IPOs in the first half of this year, Massachusetts accounted for just $209 million, or about 3 percent, compared with 11 percent on average for the past decade, the NVCA said this week.
Part of the reason, says Bill Aulet, managing director at the MIT entrepreneurship center, is that Boston’s venture capitalists have traditionally focused on industries that make “real products” such as software, telecommunications, material sciences and biotechnology.
Biotechnology startups have been the biggest recipient of Boston venture capital, accounting for about a third of investments in the region over the past five years. MIT president Susan Hockfield, a neuroscientist, said in her 2005 inaugural address that she wanted the school to lead in that field.
Many of the region’s venture firms are based near Route 128, a highway that connects Boston’s western suburbs in a semi-circle and was once nicknamed America’s Technology Highway. The area is still home to companies such as Raytheon Co., the biggest maker of missiles, Thermo Fisher Scientific Inc., the largest maker of laboratory instruments, and Biogen Idec Inc., the world’s largest maker of multiple sclerosis medicines.
Being outside of the city made it harder for firms to stay in touch with students, said Kate Castle, vice president of marketing at Boston-based Flybridge and a board member of the MIT Enterprise Forum Cambridge, which helps connect technology entrepreneurs.
“The T doesn’t go out there,” Castle said, referring to the Massachusetts Bay Transportation Authority, operator of the public transportation system in the area. Students are “not going to rent a car.”
To be closer to the universities, at least seven firms have opened offices in Cambridge in the past two years and one, Charles River Ventures, is planning to do so. Spark Capital, one of the early investors in Twitter and Tumblr, started in downtown Boston six years ago.
“We were on Newbury Street right in Back Bay, and everyone kind of laughed at us,” said Alex Finkelstein, 35, a general partner who’s been with Spark since the beginning. Now, “we’re seeing more of these old-school firms moving from 128 into Boston or Cambridge because that’s where the entrepreneurs are.”
Zuckerberg’s Facebook tried to raise money in the Boston area in 2004 and was turned down by Battery Ventures, a firm in the suburb of Waltham that helped start companies such as Akamai Technologies Inc., which sells server space that helps websites load faster, and wireless communications provider MetroPCS Communications Inc.
Turning Down Facebook
Facebook is currently valued at $82.4 billion on SharesPost Inc., a secondary exchange for shares of private companies. The company may seek an IPO in the first quarter of 2012 with a valuation as high as $100 billion, CNBC reported June 13, citing people familiar with the matter.
“It’s not Boston’s historical strength,” Sunil Dhaliwal, a general partner at Battery, said about the consumer Internet business. “Relative to other geographies, we’ve been playing catch-up.”
Part of the reason Facebook didn’t find funding in Boston, and that area firms missed out on the social networking boom, is because many didn’t grasp its significance, said Howard Anderson, 66, a senior lecturer at the MIT Sloan School of Management and co-founder of Battery Ventures. The average angel investor in Boston is about 55 years old. In California, it’s 32, he said.
“It became a generational issue. You couldn’t really understand social networking here,” he said. “To understand things like Facebook, you have to be 19 to 24 years old. If you’re 56, you don’t quite get it.”
Battery, formed in 1983 in Boston, used to find technology deals because partners would hang around MIT’s campus in Cambridge, Anderson said. The firm moved to Wellesley and then to Waltham so it could have enough space to help set up entrepreneurs and their businesses, said Amy Grady, a Battery spokeswoman.
Many Boston-area venture capitalists also cringe at the implied valuations of some Internet companies. At its current valuation, Facebook would be worth 59 percent more than Ford Motor Co., the second-largest U.S. automaker, and more than twice as much as BlackRock Inc., the world’s largest asset manager.
Groupon Inc., the online coupon website, has an implied valuation of $10.4 billion, according to SharesPost, on revenue of $713 million last year. In comparison, discount retailer Dollar Tree Inc. has a market value of $8.5 billion and sales of $5.9 billion.
‘Getting Too Excited’
“They’re getting too excited,” Anderson said of the investors in the companies. “For people who say this is not a bubble, I reminded them that 10 years ago they were saying, ‘it’s different this time.’ And it never was.”
Fifty-three Internet companies have filed for U.S. IPOs so far this year, the most since 164 companies in the industry announced plans for initial offerings in the U.S. during all of 2000, data compiled by Bloomberg show. By contrast, just three biotech companies have filed for IPOs, down from 46 in all of 2000.
LinkedIn Corp., based in Mountain View, California, saw its shares more than double in value on May 19, their first day of trading. The stock has been little changed since then. Oakland, California-based Pandora Media Inc. has gained 15 percent from its IPO price of $16.
Greylock Moves West
Greylock Partners, founded in 1965, two years ago moved its headquarters to Menlo Park, California, from Waltham, where it was based for 44 years. The firm, which has backed companies such as Vertex Pharmaceuticals Inc., the drugmaker whose first medicine was approved this year, moved its East Coast office to Cambridge last year.
Greylock was an early backer of LinkedIn, Facebook and Pandora and a recent investor in Groupon, whose IPO may value the company at as much as $25 billion, people familiar with the matter said in March. Greylock general partner David Sze led the firm’s investment in Facebook in 2006.
Apart from Silicon Valley, New York has been among the biggest beneficiaries. It is home to consumer Internet start-ups such as Gilt Groupe Inc., Foursquare Labs Inc., which lets people use the Internet to broadcast their whereabouts, and Tumblr Inc., a microblogging site.
“It’s amazing what’s going on there,” said Aulet, who helps connect aspiring entrepreneurs at the MIT. “You can just feel the excitement in the air.”
New York’s Gain
Venture investments in New York metro-area companies totaled $580 million in this year’s first quarter, equal to 10 percent of the total nationwide, compared with $639 million in the New England region, which had an 11 percent market share. New York’s share was about half of Boston’s seven years ago.
Flybridge’s Greeley said there’s a “historic frustration” that schools like MIT and Harvard educate students only to see them leave. Cambridge has the highest number of Ph.D.s per capita in the United States, according to the most recent data available from the U.S. Census Bureau.
“We tend to focus on things that are hard and novel,” Greeley said. “The novelty of Facebook was the social outlet, it wasn’t the technical insights.”
There’s some evidence Boston firms are getting back into the game. Spark, founded by Todd Dagres, a former partner at Battery, Santo Politi, a partner at Charles River Ventures, and Paul Conway, a former Charles River finance chief, has been among the most visible investors in social media since it was started in 2005. Bijan Sabet, who led Spark’s investments in Twitter and Tumblr, also sits on Twitter’s board.
Return to Harvard
General Catalyst Partners in Cambridge is backing Kayak, the seven-year-old online travel management company that has registered for a $50 million IPO.
Andrew McCollum, who was part of the original Facebook team at Harvard until he left in 2006, said there is much more excitement now about entrepreneurship at the school and in the city than when he left.
“It was just really amazing, the difference in the environment and enthusiasm,” said McCollum, 27, who returned to Boston last year and is now entrepreneur-in-residence at Flybridge. “I saw tons of people, and they told me that CS50, the intro computer science class, is now one of the biggest courses at the school. It’s taught in Sanders Theater, the biggest lecture hall on campus.”
Finkelstein says people who were skeptical of Spark’s investments in Tumblr and Twitter a few years ago don’t laugh now. Twitter is raising funding that values the company at about $7 billion, a person familiar with the matter said this week. That’s almost twice as much as the company was worth in December when it received a $200 million investment led by Kleiner Perkins Caufield & Byers.
“We invested in Tumblr when it was a one-person company, Twitter when it was a 15-person company,” he said. “A lot of people thought we were crazy for those investments when we made them, and now the valuations speak for themselves.”