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Facebook IPO has halo effect for venture capitalists

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05/13/2012 | 02:18pm CEST

For the handful of venture capitalists who backed Facebook in its early days, a huge financial payoff is not the only thing they may be celebrating when the company goes public later this week.

In a business in which the best investment opportunities flow to a small number of firms with big reputations, the prestige boost that Accel Partners, Greylock Partners and Meritech Capital have gained from their Facebook investments dating back to 2005 and 2006 could pay dividends for years to come.

"The person, often the firm too, gets that patina," said Lisa Edgar, who tracks a range of venture investors in her work evaluating venture-capital firms for fund-of-funds firm Top Tier Capital Partners. "It perpetuates. There's this deal-flow and network effect."

The dynamic is straightforward, but powerful. Entrepreneurs see a firm, or an individual partner, that not only made a great call but now has a special relationship with a company that could help their nascent business. That means that the venture capital firm gets first dibs on some of the most promising deals, which vastly increases their odds of success.

And their link to Facebook means in some cases an easy introduction, or even a deal down the road, for the venture capitalists' portfolio firms. Take Facebook's $1 billion acquisition last month of photo-sharing service Instagram - just after Greylock funded it.

Other venture capitalists also start paying more attention to what the successful firm is doing, and although they would be loath to admit it, they may become more inclined to back those same companies at richer valuations in later rounds of financing.

The limited partners who provide the funding for venture capitalists in turn see both the big financial return from the initial investment and the fringe benefits to other portfolio companies, and become more inclined to support the successful venture capital firm in the future.

'GIVES THEM CONFIDENCE'

Josh James, the former chief executive officer of the software company Omniture, is just the sort of entrepreneur that most any venture capital firm wants to back - he had sold Omniture to Adobe Systems for $1.8 billion in 2009.

He had his choice of funders when he was building his new software company, Domo, and went with Benchmark Capital last year in part because of Benchmark Capital partner Matt Cohler's close ties to Facebook.

James said he has sealed a deal to hire more than one employee by telling them that likely they eventually would get to present to Cohler, and he has closed several sales because the Facebook connection makes it clear to customers that Domo is up on the latest technology.

"It gives them confidence," he said.

Earlier this year, Domo raised $20 million more from Institutional Venture Partners.

At education network Edmodo, which took $15 million in funding from Greylock and Benchmark last year, the Facebook connection "brings credibility to us, too," CEO Nic Borg said.

Borg said he believes several education companies developed applications to run on Edmodo's platform that they might not otherwise have done so.

At business software company Couchbase, CEO Bob Wiederhold says the upside lies in large part on the introductions that Accel's Kevin Efrusy, an investor in his company since 2010, can make. That includes to Bobby Johnson, director of engineering at Facebook and now an advisory board member at Couchbase.

"He can help surround the company with good people," Wiederhold said, referring to Efrusy.

THE BIG COMEBACK

Facebook's earliest backers are sitting on a veritable fortune. Meritech's and Greylock's slices of Facebook will be worth more than $1 billion each.

But Accel Partners, which initially invested $12.7 million in Facebook at a $98 million valuation back in 2005, the year after it was founded, is clearly the big winner. Come the IPO, the current stake of Accel and its affiliates will be worth $6.3 billion, assuming a mid-point stock price of $31.50. It plans to sell a portion of that stake worth about $1.2 billion, according to the IPO prospectus.

Accel won in more than one way. It had been struggling in the wake of the dot-com bust that began in 2000, and the firm's fund that in 2005 first started investing in Facebook and other companies turned Accel's reputation around. Its latest funds, including last year's Accel XI, have been heavily oversubscribed by investors.

The deal was also a career-maker for Accel's Efrusy, who was not even a partner when he made the case for a big investment in Facebook at what was considered a very high valuation at the time. Efrusy went on to back social-discount company Groupon early on, in 2009, well before its IPO raised $700 million last year.

For Greylock Partners' David Sze and Meritech Capital's Paul Madera, both of whom jumped into Facebook as part of a $27.5 million round in 2006 that valued the company at $500 million, the deal was not their first big success.

Sze was an early investor in LinkedIn, which raised $352.8 million in an IPO last year, and Madera backed enterprise-software giant Salesforce.com before it went public in 2004.

Cohler invested sweat equity by leaving a job at LinkedIn in early 2005 to become Facebook's seventh employee before becoming a venture capitalist. At his new employer, Benchmark Capital, which does not invest in Facebook, he led a $7 million investment last year in Instagram.

Despite their extraordinary success, none of the early Facebook investors appears ready to rest on the laurels.

"You have to be humble about whether you can do it again, and that's what keeps you hungry," said Greylock's Sze.

"If you look at the cycle, every four to six years another company of (Facebook's) caliber gets created," said Chi-Hua Chien, currently a partner at Kleiner Perkins and a former associate at Accel who first brought Facebook to the Accel team's attention. He rattled off a list of names including: Amazon, in 1994; Google, in 1998; and Facebook, in 2004.

The outsized importance of the occasional monster deals means that venture capital firms sometimes find it worthwhile to get in - even late in the game.

Andreessen Horowitz, a high-profile new firm, drew some snickers when it bought Facebook shares in 2010 at a very high valuation. But that investment stands to show a tidy profit, and with partner Marc Andreessen sitting on the Facebook board, it is not hard to see the benefit for the firm.

(Editing By Jonathan Weber and Will Dunham)

By Sarah McBride

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