Testing Time for the VCs

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Numerous start-ups financed before this spring's shakeout, not to mention the VCs who funded them, are learning that the hard way. In the past couple of months, any number of highly touted outfits, from Web portal AltaVista to (a DVD e-tailer), have had to postpone or withdraw planned public stock offerings; many of them need additional private funding, and fast. Others have already faced euthanasia. In May, only a few months after , the European high-end sports fashion e-tailer, launched its flashy site, it was forced to call it quits. The same VCs who lavished $120 million on the fledgling enterprise, including LVMH chief Bernard Arnault and Goldman Sachs, had quickly grown tired of its free-spending ways and wouldn't give it any more cash to play with.

For many of the new corporate VCs, though, cashing out is not the primary goal. When most nonfinancial companies start writing checks for entrepreneurs, they have a more limited, strategic agenda. Intel uses its $8 billion venture portfolio to fuel demand for its fastest microprocessors. Database king Oracle, which scored a whopping 600% return in its rookie year as a VC, launched its $500 million fund with an eye toward helping outfits that "are outside our core competency but good for the Net generally," as senior V.P. Matt Mossman puts it. Following the Japanese model of keiretsu, many firms hope their financial, marketing and technology support will establish a tight network of suppliers and (deeply indebted) customers.

Most old-economy ceos feel they simply have no choice but to join the speculative venture game, regardless of the prevailing Wall Street winds. Since 1996, the number of firms with venture programs has quadrupled, to 200, according to Asset Alternatives. They include Chevron, Starbucks and Sara Lee, among others. It's all about "avoiding extinction," says VC Tim Draper. To keep pace with the new economy, the argument goes, Fortune 500 ceos need to own a stake in it--finding innovation outside their doors.

"It's a good way to do research and development and stay on the leading edge," says Greg Quesnel, CEO of shipping firm CNF, which has set up a fund. When it comes to white-collar service professionals, acting as a VC is sometimes simply the price of doing business with cash-strapped dotcoms--and keeping your own employees from fleeing to them. At several San Francisco law firms, partners are pooling money to give start-up clients seed capital. Many consulting and accounting firms are accepting stock for services, providing so-called sweat equity. Still others, like Andersen Consulting, which has established a $1 billion fund, are directly investing the firm's money and giving their workers a share of potential profits in lieu of stock options. These companies stress that the newfangled relationships will not compromise their independence, but there are more material risks. "We are excruciatingly aware that this paper could turn out to be worthless," says McKinsey & Co. senior partner Dick Foster. "But we're in the age of equity."

Well-off individual investors want their share too. Across the country, people who have had no access to the rarefied world of private offerings can use the Web, at and , to hook up with start-ups. Every month about 85 women from the District of Columbia area who make up get together to decide how they will make their next bet. Each member puts in $75,000 over three years, and there's a 50-person waiting list.

There's also a whole new class of entrepreneurs trying to help one another build start-ups. Pioneered by Bill Gross's Idealab, which got eToys (among others) off the ground and has filed to go public, the so-called incubators have become the latest entrepreneurial fad. With names like Thinktank and eHatchery, they typically provide a combination of office space and recruiting, legal and financial help to aspiring dotcom entrepreneurs in exchange for a chunk of the new firm. A group of Duke University graduates has launched its own college incubator, StartEmUp, to "take your idea from the dorm room to the boardroom," as its slogan goes.

Some skeptics criticize incubators for taking a cookie-cutter approach to innovation, but Jake Winebaum, a former Disney executive who co-founded ECompanies, thinks the hand-holding he provides is invaluable. "There's capital out there, but it's execution that counts," he argues.

And that, for many VC wannabes, is precisely the problem. They may have some spare change to throw around, but most are not likely to have the necessary networking skills and business experience, which are just as important. It may be only a matter of time before the new VCs, like the Net stocks, suffer a shakeout.