Benchmark had always defined itself strictly as an early-stage investor, but when it invested $19 million in 1-800-Flowers, the partners rolled the dice on a "mezzanine" investment - an investment in a company poised to go public. That proved costly. 1-800-Flowers is the one company in the fund that has gone public. But by September 30, 2000 it had racked up a loss exceedig $10 million for the fund, according to InsiderVC.com. After publication of this story, Benchmark said that loss has fallen to $2 million.
Compounding its bad bets, Benchmark failed to hold back enough of its reserves for further financing. VCs usually reserve about half of a fund's cash to make later investments in its most promising companies. Within the venture world, it's generally frowned upon to pull money out of a new fund to salvage a company funded by a previous one. According to its contract with limited partners, Benchmark is permitted to cross-pollinate between funds, but doing so, experienced VCs say, raises the question of whether you're trying to cover for old mistakes with new money.
In general, VCs try to avoid such cross-fund investments. "It's something you should do very rarely and only when you have complete confidence in a company," says Geoff Yang, a 16-year VC veteran. "Otherwise, there are huge opportunities to get second-guessed by your limited partners, who might think you're using one fund's money to prop up the investment of another." On at least three occasions, Benchmark has dipped into fund IV to invest in fund III companies, including a $3 million investment in the now-defunct Living.com.
Still, Benchmark remains confident in fund III's long-term performance. Despite the carnage so far, the firm is convinced at least five of the surviving companies could single-handedly provide a $1.5 billion return. VCs by nature are an optimistic bunch, but the boys of Benchmark may be an extreme example of the breed. The world around them has changed dramatically, yet they still believe that a $1 million investment in fund III will eventually return $150 million to investors.
That would take quite a turnaround. Until then, Benchmark, like other VC firms with hangover funds, can try again with newer funds, for which they've so far had little problems raising money. The question is, will their reputations recover as easily?
Kathi Black, Diana Moore, Katie Motta and Jeff Palfini contributed to this report.
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Correction: An earlier version of this article should have stated that Benchmark Capital's third venture fund has invested in a software company, Collabra. Also, due to an editing error, the story should have stated that Benchmark III has no investments in networking equipment, and that the $10 million loss the fund faced on an investment in 1-800-Flowers was as of Sept. 30, 2000. Additionally, the story incorrectly stated that Tim Draper is an investor in Red Herring. |
