Silicon Valley lures unusual mix of prospectors, despite fears too much money is chasing too few good ideas

Venture capitalist Greg Sands of Costanoa Ventures raised $175 million for a new fund this past summer.

Venture capitalist Greg Sands of Costanoa Ventures raised $175 million for a new fund this past summer. PHOTO: MATTHEW ENBAR

By Eliot Brown

Nov. 21, 2017 5:30 a.m. ET

14 COMMENTS

PALO ALTO, Calif.—Longtime venture capitalist Greg Sands is no heavyweight in Silicon Valley. His young firm, Costanoa Ventures, has made unglamorous investments in business software, and its profits are almost all on paper.

Yet this past summer, the 51-year-old Minnesota native raised $175 million for a new fund with relative ease, shunning investors who wanted to pump in more money. “This went pretty much according to plan,” he said with a chuckle.

Silicon Valley is bursting with fledgling venture-capital funds like Costanoa, thanks to a seemingly endless flood of cash from college endowments, nonprofit foundations, pension funds and wealthy executives who are craving tech riches in a low-interest world. The money continues to flow despite persistent worries from industry veterans and observers that startups are overstuffed with capital and have generally returned little in profits through initial public offerings and acquisitions.

The rush has brought an unusual mix of prospectors. In addition to veterans like Mr. Sands, there are wealthy Google and Facebook Inc. engineers who want to try investing, celebrities such as the band Linkin Park and basketball stars Carmelo Anthony and Kobe Bryant, and big corporations like 7-Eleven and Campbell Soup Co. all spraying money on tech. Just since this summer, two separate venture firms were started by former Airbnb Inc. employees.

New Money

The number of first-time venture capital funds in the U.S. has surged in the past 10 years.

Through 3rd quarter

Total

140

funds

120

100

80

60

40

20

0

’13

’12

’14

’16

’10

’15

’09

2007

’11

’17

’08

Source: DowJones VentureSource

Since the start of 2013 through September of this year, 516 venture capital funds were raised by U.S.-based firms new to the sector, including a record of 133 last year and another 87 in this year’s first nine months—on pace for a slight downtick—according to data compiled by Dow Jones VentureSource. The five-year total is double the level raised in the prior five years. The bulk are small funds with less than $100 million.

Venture firms raised $44 billion last year, the most since the dot-com boom. The mushrooming of new venture outfits is widely viewed by investors as unsustainable, with too much money chasing too few good business ideas.

Most investors betting on new venture funds “are in a state of denial,” said Mike Maples, whose seven-year-old Floodgate Fund was early to the wave of so-called seed funds that invest in companies to help the get started. “They’re not going to get a good venture return,” he said.

A shakeout will take time. Venture funds typically have a life of 10 years as they try to return profits to their investors. It is a ruthless sport: A few megahits can carry a fund, while the rest may produce marginal or no returns at all.

The most desired venture firms consistently deliver a large chunk of the industry’s profits, so only a sliver of new funds can hope to crack into the top tier. Venture capital overall has underperformed the Nasdaq Composite Index in most years since 2000, according to data from Cambridge Associates. So venture firms often must be in the top quartile or better to beat the public markets.

Meanwhile, the influx of money may be cushioning startups with shaky business models. Far fewer startups have gone belly-up in recent years compared with decades’ past, while venture capital-backed company formation has soared, according to Dow Jones VentureSource.

Celebrity and novice venture-fund operators say they recognize the risks. Many have brought on venture professionals to help, each emphasizing a niche. Bradley Tusk, a political consultant who ran Michael Bloomberg’s mayoral campaign in 2013, jumped into the world when he did some early political consulting for Uber Technologies Inc., having been paid in equity. Now he has raised a $36 million fund meant to invest in startups that use his political consulting, potentially giving him a seat at the table for hot investments.

“I really enjoyed working with startups—it’s the closest thing to a political campaign,” he said. “There’s a lot of upside.”

Payout

Since 2000, even the top quartile of venture funds has underperformed the Nasdaq in some years.

Returns on performance of venture funds

80

%

60

40

20

Nasdaq

Composite

Upper quartile

Lower quartile

0

–20

’95

’90

’00

’05

’10

’86

’15

*Index of Nasdaq Composite returns modified by

Cambridge Associates

Source: Cambridge Associates

The most sought-after venture firms, such as Sequoia Capital and Benchmark, rarely let in new investors. So financiers like Richard Chau, who oversees private equity and venture investments for Tulane University’s endowment, must sort through a barrage of entreaties from less established venture-capital managers. “There’s just an incredible amount of money coming in,” he said. “Everything’s overvalued.”

Mr. Chau has only put money into a handful of venture firms thus far, including an education-focused tech fund and Costanoa. He said he flew out to meet Mr. Sands and Costanoa’s team earlier this year, finding the firm to be more prudent and experienced than most new firms.

If Silicon Valley is all about flash and brash these days, the mild-mannered Mr. Sands sticks out. He sports a 1990s tech uniform of khaki pants and a loosefitting button-down shirt. His investor pitches can meander, as he expounds on the shifting landscape of business software. The former early executive of web browser Netscape Communications and large venture firm Sutter Hill Ventures says he hates marketing himself, and wishes he could just focus on investing.

Many investors, he says, believe “being famous leads to high-quality deal flow. It doesn’t,” he said.

In its five-year history, Costanoa has made bets on companies showing promise like big-data startup Alation Inc., and its first fund shows paper returns that would put it in the top 25% of those surveyed by Cambridge Associates. But it is far too early to say whether Costanoa deserves a place in the pantheon of venture firms.

Still, fundraising went smoothly. Through months of calls, emails, coffees, and lengthy interviews in his Palo Alto office, Mr. Sands courted university endowments, family wealth advisers, even a New York church as he attempted to raise $40 million more than his previous fund.

“Welcome to world headquarters,” Mr. Sands said to two investors from the Texas A&M Foundation this summer, as he greeted them in his compact office next to a fitness studio.

The Texans, sitting across a new walnut table, peppered Mr. Sands with questions, from the type of chief executive he likes, to how he sets himself apart from the biggest funds. His main pitch: Costanoa has strong connections in business software, and it bets on small, stable companies avoided by the biggest venture firms.

If all goes well, “we can take 175 and multiply it by a four or a five or a six.”

After two hours, the executives left and later sent Mr. Sands a message: Texas A&M was in.

(http://www.autoadmit.com/thread.php?thread_id=3804797&forum_id=2#34740533)