Venture Capital Catches a Smaller Wave

Sequoia's new fund may signal a return to pre-bubble normalcy

Sequoia Capital always was a bit of a maverick. The 30-year-old Silicon Valley venture-capital firm doesn't participate in most industry powwows. While rivals sought headlines, it has largely shunned publicity for its partners. And it never bulked up in size and scope the way other firms did during the bubble years. So it's fitting that Sequoia is dipping its toes in the water as the first of the veteran VCs to raise a new fund since the tech bust.

But the move may not be as gutsy as it looks. For one thing, with its current funds running low, Sequoia needed to raise cash. Sure, investors are cautious about handing over more dough to venture capitalists after being left with the battered remnants of hundreds of dot-com flops. Indeed, the money committed to venture capital is expected to total just $25 billion this year, down from a high of $99.8 billion in 2000. But that still would be one of the industry's best years ever and puts it back above its 1997 level--in other words, back to what was normal before the Internet boom knocked everything off-kilter.

If Sequoia is leading the industry back to the future, it's using its pre-bubble road map. For instance, it's raising just $385 million now, far less than the $695 million it collected with its last fund in 2000, but larger than the $250 million it raised in 1998. It's also sharply cutting the number of new startups it funds, to about 15 a year, says Sequoia partner Michael Moritz. And it has halved the amount of money it invests initially in startups, from $6 million in its last fund to $3 million. "We view 1999 and 2000 as aberrations," says Moritz. "This is a more natural rate for us."

The moves reflect today's reality. Venture capitalists say it is far more difficult to put money to work than it was a few years ago. That's because many entrepreneurs are opting to wait out the tech downturn rather than jump into new companies. Valuations are down, too, meaning that venture firms don't have to put up as much to back them. And since companies are more deliberate about their growth plans, startups don't need as much cash to support their operations. "We need funds to be of a more rational size, and Sequoia is a leading indicator of where fund sizes will likely fall," says Jonathan D. Feiber, a managing partner at Mohr, Davidow Ventures, which has twice cut the size of its current fund--from $850 million to about $450 million now--since it was launched in 2000.

Sequoia certainly seems to be on the right track. Since the firm announced in November that it would soon begin raising its 11th fund, at least 200 institutions have sought a piece of the action. That's on top of commitments from current Sequoia investors who also want a share of the new fund. Sequoia says demand for the fund, which is scheduled to close at the end of March, exceeds $5 billion--even though the firm will keep its standard 30% of the fund's profits, the industry high. "The only recurring question we've heard is: `How can we invest more?"' says Moritz.

How can this be? Sequoia, like so many others in the industry, suffered embarrassing, high-profile blowups after the bubble burst. It lost millions in now-defunct or hobbled Web-based companies such as Webvan, eToys, and Scient. But investors seem ready to forgive these gaffes and focus on Sequoia's superior long-term record.

The firm has backed a who's who of past high-tech winners, including Apple Computer (AAPL ), Cisco Systems (CSCO ), Oracle (ORCL ), and Yahoo! (YHOO ), and produced impressive results. The fund it launched in 1992 returned 110% over the life of the fund, while the 1995 and 1998 funds have so far earned 175% and 96% respectively, according to data recently released by the University of Michigan, a Sequoia investor. "There's a flight to quality," explains T. Bondurant French, chief executive of Adams Street Partners LLC, a Chicago-based venture investor that would like a spot in the new fund.

Look for VCs to mimic Sequoia's strategy. In fact, a litany of other veteran firms, including Kleiner Perkins Caufield & Byers, are expected to hit the fund-raising trail later this year and next. "These guys will stop having cold feet and start looking for money to put back into the market," says Jesse Reyes, a vice-president at Thomson Venture Economics, which tracks the industry. Now, all they have to do is start making money for their investors again.

By Linda Himelstein in San Mateo, Calif.

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