Last spring, Chase Bank – one of the largest and wealthiest banks in the country, with 70,000 employees around the world – made $5.7 billion in revenue. An astonishing figure of roughly $1 billion in paper gains was logged for Chase by a firm called Flatiron Partners – which has a staff of nine, including the receptionist.
Flatiron Partners is a venture capitalist, and if you still think Wall Street’s Masters of the Universe rule the financial roost, that billion dollars Flatiron made for Chase last quarter should change your mind. VCs – as they are called in the close-knit entrepreneurial community – like Flatiron do “dash deals,” where companies raise capital or go public without the bother of details like revenues. It turns out that IPOs are more profitable than Tokyo real estate or leveraged buyouts ever were. Eighties masters leveraged businesses with junk bonds; VCs now create junk companies.
Instead of trading stocks or bonds, Flatiron invests in new companies. The trick of it is that they invest early, and heavily, in exchange for getting a substantial piece of the company. This big stake for the VCs is what once earned them the nickname “Vulture Capital” from hard-pressed entrepreneurs who – if you can believe it – felt preyed upon by wealthy venture firms. In the old days, VCs were the lenders of last resort, extortionists who demanded disproportionate returns for the use of their capital. But now, VC firms are like Ivy League colleges; the pedigree they offer a fledgling business is well worth the price. In fact, it is de rigueur on the road to a big public offering.
Unlike older VC firms heavily invested in a variety of industries, from health care to genetics to restaurant chains, Flatiron was one of the first in New York to specialize in Internet companies. And it has yet to write off a sour investment. In this high-risk world (they don’t call it venture for nothing), every single one of its 21 deals has soared so far.
VCs have a know-it-all swagger that makes Wall Streeters seem demure, even in this gilded boom. After all, what do investment bankers really know about money? Wall Street provides the plumbing that lets money flow freely, the VCs condescend. VCs, on the other hand, are the visionaries, and the outsize rewards are their eye chart.
This embarrassment of riches is an industrywide problem for VCs, who spend almost as much time turning down pension funds and other eager investors as they do saying no to start-up ideas. The money allocated to venture capital has grown with each success. In 1996, $8 billion was devoted to this speculation in the entire United States. By 1997, the number had grown to $11.5 billion.
In the past year, the wave of venture money has turned tidal: $7.7 billion in the past quarter alone, up from a record $14.3 billion for all of last year (plot the numbers since ‘96 on a graph, and you see a line go from steep to vertiginous). Fully half of the money is going exclusively to Internet start-ups. “It’s staggering,” says VC veteran Bob Fish of PricewaterhouseCoopers, which compiles the survey numbers. “It’s at a fevered pitch.”
Flatiron was founded by Fred Wilson and Jerry Colonna. Though Wilson and Colonna are old men by Internet standards, Flatiron is a new company. Established only three years ago, it is now the badass VC firm in New York, the capital of capital.
Colonna is the bouncier partner, a 1986 English-lit graduate of cuny’s Queens College who worked for nearly ten years at CMP, a Long Island publisher of computer trade magazines, before the Internet racket hit. Now he’s a kind of older-brother figure in Silicon Alley, so accustomed to being pitched business ideas that he brushes off casual encounters with a hearty “good luck” even when no one’s trying to sell him anything. Wilson, 38, is the MIT-educated engineer, the more seasoned VC with the Chappaqua house and family. Unlike eighties Masters of the Universe, both are polite and modest about their success, though now each must be worth north of $50 million.
Wilson and Colonna put the billion-dollar bulge in Chase’s pockets mainly through Flatiron’s investment in StarMedia, the Latin-American Internet portal that went public in May, and has spent lavishly to promote itself – and its stock – in the English-language media around town. The cash infusions to Star began two years ago with $3 million. The stake is now worth more than $500 million.
Because Flatiron’s structure is a bit unusual for a VC firm – all the money comes from Chase Capital Partners instead of a pool of cash raised by Wilson and Colonna – Chase kept most of that billion-dollar windfall, its price for supplying the capital. But that still left $68 million for the partnership. Another $150 million (of which Flatiron kept a cool $11 million) came from an investment in GeoCities, which was acquired by Yahoo! at the end of May. Other springtime successes included investment sites Multex.com and the slumping but still fantastically valued TheStreet.com.
Success generates more success, and the “deal flow” is up near 100 pitches a week at Flatiron Partners. “There’s plenty of business to go around,” says Flatiron’s newest partner, Bob Greene, explaining why Flatiron doesn’t mind sharing its ideas with Chase’s own 120 investment professionals in a weekly meeting that lasts several hours.
At the end of July, in a formal announcement at Flatiron’s modest Park Avenue South offices, the partners unveiled $20 million in investments spread over five companies. Beneath the $20,000 flat-panel television hanging on the wall and among the open offices that would be more in keeping with a young ad agency or a magazine than with an epicenter of wealth creation east of the Rockies, representatives from each company tried to present its idea of the future.
The snappiest presentation was a company called Kozmo.com, which delivers videos and snacks to homes all over Manhattan within an hour from the time an order is placed on its Website. The dog-and-pony show went well, but the real excitement came fifteen minutes into the next presentation, when a bike messenger delivered fifteen pints of rock-hard Ben & Jerry’s to the crowded conference room.
Joseph Park, Kozmo’s head, courted Flatiron’s Jerry Colonna for a couple of years, sending periodic e-mail updates about the business, even after raising $4.5 million in so-called angel money from individual investors like Glen Bell, the founder of Taco Bell. “You still have to do the institutional round. Flatiron’s track record for IPOs and acquisitions is second to none,” says Park. Kozmo.com has plenty of “deal heat” going for it. Flatiron’s VCs measure interest by the number of people willing to show up at any given presentation. Much of the energy obviously comes from the pitch (“Internet to your door … in under an hour”), but Flatiron’s reputation only increases the heat.
One of the other four companies Flatiron presented is led by a startup veteran with a bona fide Internet success, an Atlantan named Gregg Freishtat. He is one of a new personality type, the serial entrepreneur. He starts successful companies the way others manage their love lives: He needs the intensity of adversity.
His latest scheme is VerticalOne, which helps people centrally organize all of their Web-based accounts – bank, airline miles, stockbroker, you name it – but he is cleverly getting other sites in the Flatiron family, like TheStreet.com, to market it for him. This is the secret of a successful VC firm, which operates more like a clubhouse than like a bank.
The phenomenal success of venture capital threatens to undo itself. A midsummer correction wreaked portfolio carnage to match the shot-up Atlanta offices of All-Tech Investment and Momentum Securities. Then Internet stocks rebounded sharply last week.
No one really knows why the dot-com stocks pulled out of their dive. But it almost certainly has less to do with Alan Greenspan and interest rates than the fact that the flood of Internet IPOs suddenly turned into a trickle. This solved a supply problem (the market has been swamped with shares faster than the public can absorb them) that has been dragging on Internet stock prices. Some 140 Internet companies have already gone out this year. Dozens more, however, are waiting in the wings for an Autumn liquidity event.
That’s why last week’s Internet recovery is a catch-22 for VCs like Flatiron. When all the Wall Street underwriters get back from the Hamptons, the biggest threat to Internet stock prices won’t be the lull before summer earnings are announced in October. It will be all this venture-capital money looking for exits.