The Art of Selling Out

The Midas List
The Art of Selling Out
Erika Brown 02.12.07

Cashing out privately is the fastest road to riches in technology. Is the IPO a quaint thing of the past?

Roelof Botha has been a venture capitalist for three years, and he dreams of putting up the early money for a Google (nasdaq: GOOG - news - people )-scale success that is adored on Wall Street and feared by rivals. But Botha, 33, is one of the hottest dealmakers in Silicon Valley for taking the opposite tack: selling out.

Botha joined Sequoia Capital, one of Silicon Valley's elite venture capital firms, in 2003; he had helped run the PayPal online outfit. In February 2005 two PayPal pals of his started a video Weblet called YouTube. Botha put up $8.5 million in Sequoia cash for a 30% stake. In November Google bought YouTube for $1.65 billion in stock. Sequoia will reap a 65-fold return, catapulting Botha onto the Forbes Midas List of top tech dealmakers; he ranks 23rd (see p. 49; full list of 100 dealmakers, plus stories and video interviews, is at forbes.com/midas).

Yet Botha is comically tortured by the sellout: If YouTube had stayed independent, how much more could it be worth? PayPal went public in 2002 but sold itself months later to Ebay for $1.5 billion; on its own it could be worth $10 billion by now. "In retrospect, selling it for $1.5 billion seems like a mistake," he says.

Uh-huh, sure it does. Selling out is now standard practice in Silicon Valley, and Botha is one of the new guard's reluctant moneymen. VC firms long had prized public offerings as the apotheosis of wealth creation. Now acquisitions offer the best and fastest payoffs.

Many venture capitalists insist this isn't so, and some warn of the ills of building startups to flip them like burgers rather than nurture them all the way to an IPO. "The way venture firms succeed relative to other people is to get stuff through the IPO market," says Benchmark Capital's J. William Gurley, 54th on the Midas List. "The odds of getting an M&A; deal done are low enough that it can never be the core strategy." Yet his firm sold Avamar to EMC in November for $165 million, after it raised $50 million in venture capital.

And while many VCs deny they want to sell out, privately they are eager. Ross Levinsohn just quit as head of News Corp. (nyse: NWS - news - people )'s Fox Interactive Media unit, overseeing the acquisition of nine firms for a total of $1.3 billion since June 2005. At a recent tech conference he got mobbed by VCs desperate to sell. "I couldn't get through the door. There were people grabbing me. It was a feeding frenzy."

Last year 56 new tech firms went public, but more than 400 got acquired, often at better prices. Why subject thyself to Sarbanes-Oxley hassles and fickle investors when Cisco (nasdaq: CSCO - news - people ), IBM (nyse: IBM - news - people ) and Microsoft (nasdaq: MSFT - news - people ) eagerly gather up fledglings at fat prices? Vonage (nyse: VG - news - people ), the Internet phone company, went public in May and raised $531 million, but since then its stock is off by 60%.

VC firms raised $25 billion in new money last year, and they cashed out $35 billion from private sales and a few stock offerings--the biggest year for tech since 2000. In selling out, VC firms reaped an average of $77 million per deal, in return for an investment of $20 million. Companies that went public brought in an average of $66 million in their IPOs, in return for an initial investment of $50 million.

"Venture capitalists need to get over the IPO fantasy," says David Carlick of VantagePoint Venture Partners, which was part of the group that sold MySpace to News Corp. for $580 million in 2005.

But Sequoia's Botha clings to his big dream. He says high-tech upstarts must be built for longevity, not for speed of buyout. YouTube's founders, Chad Hurley and Steven Chen, "were always talking about ways to draw people in and make it better, not how they could tweak it so they could get a better acquisition price. That is a hallmark of all the great companies."

Sequoia just raised an $800 million fund, and Botha is deep into consumer Web plays like InsiderPages (a network of community guides) and Xoom (a new take on Western Union). They aim to expand their user ranks cheaply and virally, à la YouTube. "I think of myself as just another consumer," he says.

Botha was born and bred in South Africa, the grandson of Roelof (Pik) Botha, a foreign minister (1977--94) in the apartheid government who supported the release of the imprisoned Nelson Mandela and later served in his government (1994--96). The grandson recalls the tense times and how his grandfather was besieged by people when the family went out to eat. "Part of why I came here was to not be someone's grandson but to just be me," he says.

He graduated college in South Africa in 1996, joined McKinsey & Co. and came to the U.S. in 1998 to attend Stanford Business School. He became chief financial officer of PayPal while finishing his M.B.A. Shortly after selling to Ebay, Botha was lured to Sequoia by Michael Moritz, who is number one on the Midas List for the second consecutive year.

Moritz put Sequoia into PayPal and Google, reaping huge payoffs by ignoring buyout offers and letting the companies make it through public offerings. "The [Sequoia] companies that have eventually become large," says Moritz, "have all started with an idea which, at first, seemed small and tenuous." Assuming no one sold too soon.

But some VCs now plan for the sell-out. "It forces a change in how you build your companies," says Kevin Compton, cohead of Radar Partners. You don't need a massive sales force if you know you can sell out to Cisco.

And why hire lab coats? Alta Partners' Daniel Janney (99th on Midas) and the Alta board members at Angiosyn assumed they would have to fire the research team if they sold to big pharma. So they never hired one, instead using outside researchers to develop a drug for the eye disease macular degeneration. Pfizer (nyse: PFE - news - people ) bought Angiosyn in 2005 for up to $530 million.

Some startups try to line up big partners, or sell wares to them, as a way to invite a takeover offer. Todd Dagres, formerly of Battery Ventures, put up $18 million of a total $37 million pumped into Broadbus, a video hardware company. Early on Broadbus identified Cisco, Motorola (nyse: MOT - news - people ) and Sun Microsystems (nasdaq: SUNW - news - people ) as possible suitors. Last year Broadbus signed on Motorola as a sales partner. "Next thing you know, Motorola makes an offer," he says, snagging Broadbus for $200 million. Dagres, now at Spark Capital, made 3.5 times his money. The company would have needed two years and $25 million more to go public. "We figured, why wait?"

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