By PUI-WING TAM
Silicon Valley's technology boom is giving a lift to the venture-capital industry.
But many of the gains are being disproportionately reaped by brand-name venture firms, which are benefiting from a wave of Internet IPOs and the soaring valuations of closely held companies such as Facebook Inc.
In what is a volatile business, some of the bigger venture-capital firms have forged ahead, taking advantage of their longtime network of entrepreneur contacts and building on past investment successes to continue getting access to the hottest deals. That helps those firms maintain an edge against less established venture firms, which in turn affects performance and returns.
Top venture-capital firms Accel Partners, Sequoia Capital and Redpoint Ventures have the biggest volume of initial public offerings and sales of start-ups so far this year, according to an analysis by VentureSource, with all three firms each notching at least nine such "exits" in the first half of 2011. In contrast, more than 200 venture firms have had only one exit each so far this year, with scores of others having none.
Sequoia's recent winners include the IPOs of social-networking company LinkedIn Corp. and Chinese Internet company Qihoo 360 Technology Inc., while Accel—Facebook's biggest outside investor—reaped the IPO of Fusion-io Inc., a data-storage tech company whose biggest customer is Facebook. Redpoint last week saw its investment in HomeAway Inc. bear fruit, with the online vacation-rental site's shares closing up 49% on its IPO.
With such deals, top venture firms are widening the return gap between themselves and the average venture fund, investors say. While firm-by-firm return data isn't readily available since gains are often spread across multiple venture funds, overall venture funds produced returns of 13.5% last year on a pooled basis—the first time the industry generated double-digit returns in a year since 2007, though below the S&P 500's rise of 15.1%—and distributed $13.1 billion back to investors, who put in $13.2 billion, according to Cambridge Associates, which tracks venture-fund performance.
Such returns still pale in comparison to the dot-com boom years of the late 1990s, when venture funds generated 27% in 1998 on a pooled basis and 281% in 1999, according to Cambridge Associates. Still, returns of venture funds from top firms has now "widened" over some other top performers "by two to three times" over the past year, says Mel Williams of TrueBridge Capital Partners, a Chapel Hill, N.C., firm that invests in venture funds. "A handful of managers are clearly distancing themselves from the pack."
While the results are a boon for the venture business, which struggled with meager returns amid a tepid IPO environment for much of the past decade, the cleaving in venture performance is likely to continue. Hot Web companies Groupon Inc. and Zynga Inc. are preparing to go public, with their IPO gains likely to be reaped by the top venture names that backed them.
That already is having a knock-on effect on fund raising. While brand-name venture firms have easily raised new cash this year—Accel last month closed two new funds totaling $1.35 billion—others are lowering their ambitions. Venture firm GGV Capital, for one, recently reduced the target size for a new fund to $500 million from $600 million, said a person briefed on the matter. GGV didn't respond to requests for comment.
Accel, the Palo Alto, Calif., venture firm, has scored the IPOs of Fusion-io, software maker Responsys Inc. and Chinese social network Renren Inc. this year, as well as closing the sale of Diapers.com parent Quidsi Inc. to Amazon.com Inc. for about $500 million.
But one of Accel's biggest returns in the past year came from a nontraditional "secondary" deal. In November, Accel sold a small piece of its Facebook stake to other investors at a $35 billion valuation, yielding about $517 million and a return of 250 times its investment.
Not all of Accel's recent exits have been hits. Acquisitions of mobile-technology start-up Volantis Systems Ltd. and SurfKitchen Ltd., also a mobile-tech company, didn't provide big gains, said a person familiar with the matter. But those are likely to be more than offset by pending IPOs of three other Accel-backed companies: Groupon, online travel site Kayak Software Corp. and online marketplace IronPlanet Inc.
"We're at the beginning of a strong positive cycle for Internet public offerings and acquisitions," says Jim Breyer, an Accel venture capitalist. He says the firm is now looking to invest in companies that "sit at the intersection of social gaming, social networks and mobile networks," citing a recent investment in "Angry Birds" maker Rovio Mobile Ltd. as an example.
For Sequoia, one of its biggest recent winners is LinkedIn, in which the Menlo Park, Calif., venture firm invested in 2003. Others include the IPO of Mumbai-based garment maker Lovable Lingerie Ltd., and the closing of a $700 million sale of ITA Software to Google Inc.
Sequoia venture capitalist Michael Moritz said the firm's investment in LinkedIn—of which it owns nearly 18% in a stake that was valued at about $1.6 billion as of the market's close Thursday—is indicative of how the firm typically invests early in a start-up and then partners to expand the company. That is in contrast to a recent wave of outside money flooding into Silicon Valley looking to get into hot start-ups as they get ready to go public.
"The Valley goes through phases, and right now we're in one which is as sure a guide as any that there's a disaster in the offing," Mr. Moritz says. He adds that some investment prices are getting too high as latecomers rush into deals.
Sequoia has recently invested in some off-the-beaten-track deals, including the Melt, a fast-casual restaurant business specializing in grilled-cheese sandwiches. The start-up was founded by Jonathan Kaplan, who previously ran the company that made the Flip videocamera. "Life would be boring if you kept investing in things you'd done before," Mr. Moritz says.
Redpoint's recent gains stem from IPOs such as those of Qihoo, Responsys and HomeAway, among others. HomeAway was the firm's most sizable recent exit, with Redpoint's 17.8% ownership stake valued at about $588 million at Thursday's end of trading.
Redpoint partner Geoff Yang says there has been a spurt of venture-backed exits because many companies in rapidly growing Web sectors survived the recession, gained critical mass and now are at the point where they are ready to go public or be sold. "We're getting to a more normal period" after the downturn, he says.
Write to Pui-Wing Tam at email@example.com