Fallen VC Idols

Of course, many venture funds are still so young that a couple of big hits could cover a long list of bad bets. In the image-obsessed world of VCs, however, even one down year is the kind of thing that could tarnish a firm's reputation.

"The way venture capital works, or at least used to work, was you invested in a fund over two or three years so you captured several years' worth of trends," says one longtime venture capitalist who, like most VCs and limited partners interviewed for this story, would only speak anonymously. "But in '99, you saw some well-known VCs go through their whole wad in a six- to nine-month time frame, so they only captured a partial year of trends. Those are the funds the limiteds are worried about."

Eighteen months ago, a venture fund reporting a negative return was unthinkable. The Nasdaq was climbing toward 5000. Tech IPOs were tumbling out the door, with investment bank analysts minting new metrics to justify the skyrocketing stock prices. So venture capitalists blithely laid down tens of billions of dollars on dot-coms. The biggest risk VCs faced seemed to be missing out on the next eBay.

"If a deal was hot enough, you locked the door and didn't let the founders out until they had at least verbally committed to a deal," says Neil Weintraut of 21st Century Internet Venture Partners. "We realized only once it was too late that we forgot to pay attention to this one important factor called profitability." It's a confession akin to a pro-ball scout proclaiming a player has all the intangibles to become a starter in the NBA - except he can't shoot.

VC money legitimized the dot-coms, and stock investors legitimized the investments with inflated valuations. The highest-profile VCs got drunk on their own celebrity and personal wealth. At the peak, stars such as Redpoint Ventures' Geoff Yang were wondering aloud whether there was any downside left in the game. "If the company doesn't work out, we'll sell for $150 million," Yang told Fortune in 1999. "If it does, it'll be $2 billion to $10 billion. Tell me how that's risk."

Yang got his answer when stocks crashed in 2000. Now the wider world no longer buys the story that dot-coms will rule the world; those flying the highest during the boom times are today's goats. The technology world's best-known investment bankers operate under a cloud of scandal as federal investigators question the legality of their IPO allotment practices. The Internet's best-known research analysts are reeling from charges they touted highly speculative stocks more out of self-interest than in a belief in companies whose shares are now trading 90 percent or more off their highs. And the venture capitalists, once lionized for their ability to spot huge hits, are getting their comeuppance. Last week, for instance, Webvan, the ultimate VC poster child last week was worth $77 million, down from a market capitalization of $2.5 billion only nine months ago.

Venture capital firms hold information about their funds' performance close to their chests - especially the current valuation of their investments. Even so, there are plenty of clues that point to a fund in trouble: How close is it to prematurely spending all the money it raised? How many of its companies have been able to raise money since the stock market crashed? How much of the fund did the firm plunk in the dot-com pot? How many startups have gone out of business in the fund's short life? And how much money are limited partners getting back on their investments?