February 20, 2003 Stocks.comment By Scott Herhold San Jose Mercury News, Calif. When I covered the venture capital industry as the bubble built between 1996 and 1999, I did a story about how universities were pouring more money into venture funds. And I was far less skeptical than I should have been. I was reminded of those days as I read reporter Matt Marshall's series of pieces Sunday about how universities and public pension funds were faring with their venture investments - and how the top-tiered VC firms themselves performed. Because of a disclosure from the University of Michigan, we have a fairly accurate picture of how venture firms soared during the bubble - and how they and their investors have suffered during the aftermath. I'd suggest it leaves us with three lessons. - First, the most stupendous results are a tribute to early money and yes, canny investing. But these venture funds did not create many companies of lasting value for public investors - which used to be one of the benchmarks for their work. The numbers suggest something very different. An exceptional fund like Matrix V, for example, returned more than five times the original money invested every year, an astonishing performance. For something like that to happen, there had to be over-eager buyers on the other end, either IPO investors or companies lusting to buy a venture-backed firm. It's a pure definition of bubble. (Matrix, for example, was an early backer of Sycamore Networks, a high-flyer that has fallen to earth). With the exception of a clutch of companies that has thrived in the public markets (Example: eBay, backed by Benchmark Capital), the astounding VC success over the last six or seven years has been the public investor's woe. To the degree that the VCs hyped immature companies - and they weren't alone - they deserve a few rotten tomatoes. - Venture capital remains a caste business. That's probably not fair. It doesn't tell you who works hard. But as an investor in a venture fund, you often get what you pay for. It's no accident that Kleiner Perkins and Sequoia Capital ended up at the top of the heap of performance according to Michigan disclosure (Other top-notch performers were Matrix and Accel Partners). During the boom, the imprimatur of a top-notch VC fund was a key ingredient in a young firm's access to money and favorable coverage. Think a Harvard degree cubed. This means there was - and is - a self-fulfilling prophecy to VC performance. Because they came with the brand, top-notch firms attracted the best entrepreneurs. And some firms - among them Kleiner Perkins, Benchmark, and Accel - raised their "carry," or percentage of the take, to 30 percent. The investors who weren't willing - or able - to swallow this took their risks elsewhere. CalPERS, for example, at first cut deals with second-tier VC firms for a lesser percentage. While CalPERS hasn't released its fund-by-fund numbers, my guess is that strategy will be less than successful by comparison. (The pension fund later loosened requirements to move into more top-tier funds). - Yes, the disclosure of the performance numbers will create fallout for the public universities and pension funds. But that's not necessarily bad. Posting the IRR's of venture firms - or "internal rates of return" - is a little like posting every person's SAT score in high school on a publicly accessible web site. A lot of people don't like it. And you can assume they'll sever relations with those limited partners forced to disclose numbers. "It's a double-edged sword," says Mark Saul, a general partner with Foundation Capital. "Limited partners in the public realm are coming under pressure to disclose. At the same time, they want continuing access to top-tier venture groups. To the degree that disclosure makes these groups uncomfortable, it's going to cause a backlash." Saul is right. But we all have to understand that public universities and pension funds should operate on a different principle than, say, the Ford Foundation. Part of the cost of doing business with public money is openness to scrutiny. The alternative - secrecy - invites far worse abuse. - Scott Herhold's Stocks.comment appears every Monday and Thursday. Write him at the San Jose Mercury News, 750 Ridder Park Drive, San Jose, Calif. 95190; e-mail sherhold@sjmercury.com; phone (408) 920-5877. To read the columns online, see www.siliconvalley.com/mld/siliconvalley/business/columnists/scott - herhold/