TBO.com - TBO is Tampa Bay Online

Venture Capitalist Shakes Up Money-Lending Business

ADVERTISEMENT

By REBECCA BUCKMAN The Wall Street Journal

Published: January 1, 2008

Three years ago, Peter Thiel, who runs a small venture-capital concern called Founders Fund, plowed $500,000 into a little-known social-networking Web site called Facebook. Later on, his company invested a bit more.

That was a good call. The paper value of Thiel's initial stake has increased more than 50 times. Facebook now ranks among the hottest online properties, with some 59 million users and investors such as Microsoft Corp. piling in.

Thiel, the former CEO of online-payment company PayPal, is making waves in Silicon Valley with an investment strategy that differs significantly from the traditional approach. His company invests only modest amounts of money, sometimes just a few hundred thousand dollars, and focuses on entrepreneurs Thiel and his partners often know personally. He also takes an uncharacteristically hands-off approach to company management.

Already, the gambit has yielded several potential winners, such as Facebook.

The venture-capital world "definitely needs to be shaken up," says 40-year-old Thiel.

His company also reflects how a new type of venture capitalist is emerging, as start-up costs for Internet companies decline sharply. Many start-ups now need a bankroll of no more than a few hundred thousand dollars to get rolling, compared with the millions of dollars required a few years ago.

More Companies Try Strategy

Other companies capitalizing on this trend include First Round Capital in the Philadelphia suburb of West Conshohocken, Pa., run by former Internet entrepreneur Josh Kopelman, who started online-commerce site Half.com and later sold it to eBay, and Silicon Valley concerns such as True Ventures and Baseline Ventures. Many of the companies now manage money for outside investors, unlike informal "angel" investors who typically make small, one-time investments with their own money.

Most traditional capital companies want to invest larger sums, several million dollars, say, for large stakes in start-ups and then exert control over the companies' operations. Some demand "liquidation preferences," or guaranteed returns if companies are sold.

Venture capitalists often can be too quick to fire start-up founders and replace them with professional managers, Thiel says. He blames a cultural divide: Many venture capitalists "have these very cushy jobs, they get paid a lot," and often can't relate to founders, he says.

With so much money chasing deals in Silicon Valley these days, start-ups can afford to be choosy in picking their financial backers. They are increasingly turning to companies like his that offer less of a "command and control" model, he says.

Thiel and his fund's other partners, including two other PayPal co-founders, Ken Howery and Luke Nosek, also claim an advantage because of their front-line experience starting companies themselves. Thiel also runs a hedge fund, Clarium Capital.

Deals Generate Envy

The Facebook coup was one of several Founders investments that have generated "a healthy amount of envy" from other venture capitalists, says Max Levchin of Slide, a start-up maker of software called widgets, or miniapplications used to decorate Web pages. In 2004, Levchin invited Thiel to be one of Slide's first investors, meaning bigger venture companies such as Mayfield Fund and Khosla Ventures could only invest later, for more money.

Thiel, who based Founders Fund in San Francisco rather than the traditional venture capital hotspot of suburban Menlo Park, Calif., is structuring deals differently from how traditional venture capitalists do. Significantly, the fund often buys only a 5 percent or 10 percent stake in a company and sets up a special class of stock that start-up founders can sell while they are building their companies and before venture-capital investors see profits. That way, the thinking goes, the company founders can reap some financial reward and stay motivated to build the company before an IPO or company sale, which can take years.

Some traditional investors don't think founders should make money before backers do, because early paydays might distract them.

Just how successful Thiel's investing tactics are remains to be seen; Founders Fund hasn't yet seen any payout from the Facebook stake. However, it recently collected a big return when one of its investments, computer-security and anti-spam concern IronPort Systems, was sold to Cisco Systems for $830 million.

Thiel acknowledges his company faced resistance from blue-chip investors when it set out to raise money for its latest, $220 million venture-capital fund.

"The early-stage venture game has always been about getting in early and getting in cheap," says Founders Fund partner Sean Parker.

Share this:

Loading Comments...

Email Print

ADVERTISEMENT