Pity the venture capitalist

Heidi Roizen is a Silicon Valley venture capitalist. And she has a problem: too much money. That, and not enough time. It's a common dilemma for people in her line of work these days.

Heidi Roizen is a Silicon Valley venture capitalist. And she has a problem: too much money. That, and not enough time. It's a common dilemma for people in her line of work these days.

Many people may not be sympathetic to her plight. Lots of coal miners and railroad workers probably didn't care much about the trials and troubles of Andrew Carnegie and John D Rockefeller.

But many of us here in Silicon Valley are very interested in the issues VCs like Heidi face because we need them. They supply the money that starts the companies that offer the well-paying jobs that are a big driver in the US economy at the moment.

Heidi is someone who's worked hard and excelled: she started her own company, has worked as a vice-president of Apple Computer and is on the boards of numerous companies, many of which she also helped to start. I recently had an opportunity to sit down and listen while Heidi explained the intricacies of her current job - she's managing director of Softbank Venture Capital, a $3bn fund that focuses on early-stage internet startups.

The venture capital profession is actually pretty interesting. Venture capitalists have figured out how to make something that is basically a losing proposition into a hugely profitable business. They've figured out how to make money by starting companies, even though four out of five startups don't make it.

Venture capitalists exist in a scary niche. Most responsible investment strategies include a small part - say 2 per cent - that is invested in high-risk stuff. The reason for this is you want insurance that you're not going to miss some big change in the world.

If all your investments are tied up in nice, profitable buggy and carriage makers, then the automobile could represent real trouble, unless you have lent a fellow named Henry Ford a few bucks to start his factory.

So big, conservative funds - pension funds, for example - invest a small percentage of their proceeds in high-risk, future-looking opportunities.

The University of California, a mammoth institution with tens of thousands of employees, has one such fund and has traditionally looked to VCs to manage part of their risk portfolio. Such funds are so big that even a small percentage will amount to tens or hundreds of millions of dollars.

The way it works is that a venture firm forms a fund, usually with a stated goal like early stage internet startups or biotech companies. Institutions like the university place their money in the fund knowing that the VC will be lending it to very shaky, nascent companies.

There is one condition: the VC has to give the money back, usually in five to seven years. So a VC isn't just free to spray money in the general direction of entrepreneurs. Their clock is ticking, as it were.

The VCs turn around and hand very large cheques - from, say, $3m-$5m - to other folks in return for almost nothing.

"Almost nothing" usually translates to something like 30 per cent of the company's-normally then-worthless shares.

VCs know better than most that eight or nine out of 10 of the companies they fund will not make it to, say, Yahoo status.

Their maths goes like this: out of each group of 10, two or three fail outright, one or two return 10 or 100 times the investment, and the rest fall into a less stellar category that one VC calls "the living dead".

A VC is looking for a company that can return 10 to 100 times the initial investment in, say, five years. About the only way for a company to do that is to grow rapidly and go public with an initial public offering (IPO).

Since VCs like to have influence, but not control, of the companies they invest in, they often take a 30 per cent stake.

Doing the maths, if a VC's $30m for a 30 per cent stake is to return $300m, then the company in question must be worth about $1bn. So a VC's job comes down to picking raw ideas and people that can turn into a $1bn market capitalisation in five years.

Turning nothing into $1bn is hard, gritty work: don't let the images of young millionaires fool you. Somewhere, somehow, a lot of hard things are getting done. At the companies that are succeeding, those things are getting done particularly well.

Heidi Roizen will tell you what she looks for when she is deciding whether or not to fund a deal: a large and growing market, a great management team, a good idea and a clear path to liquidity (remember, she has a deadline for returning the money).

And she has no shortage of suitors: on average 200 would-be deals a week come in to her office. And she has no shortage of money, either: the success of her earlier investments has caused her fund to grow to its current $3bn size. Like most venture capital funds, there is a commitment to stay fully invested.

So what's a venture capitalist to do? Even here in Silicon Valley, there are only so many hours in a day. One strategy is to add partners, but VCs are a special breed - they're hard to find. Another is to do larger deals, but big deals take a lot of work - you don't just hand somebody $30m without doing a lot of homework.

So many deals but so little time.

cg@gulker.com