VC P.S.: Idealab's other Bill

December 6, 2000
2000 Red Herring
By Lawrence Aragon



It's so refreshing to have finally met someone who can honestly say he understands the power of the Internet. Bill Elkus, cofounder and senior managing director of Idealab Capital Partners (ICP), knows it from the depths of his being.

For six years, he and his wife Leslie endured the nightmare of not knowing why their oldest son, now 13, was sick. Refusing to give up, they visited 50-plus doctors. Finally, they got a diagnosis: celiac disease, a rare metabolic disorder that prevents the body from completely digesting protein in wheat and related grains.

Determined that no other parent or child should endure the same torment, Mr. Elkus decided to create an Internet discussion group to spread the word. This was back in 1994, before the Web as we know it. One doctor wasn't optimistic about the online effort, saying he saw perhaps three celiac cases per year. He quickly found religion when the online discussion group brought together 120 people from 20 countries on its first day.

For the first time, "celiacs," their families, and their doctors were able to share information around the globe. "I got in touch with world experts that even my son's gastroenterologist didn't have access to," Mr. Elkus says.

You can appreciate, then, why Mr. Elkus, 49, is just a little more passionate about the Internet than most folks are. It was that passion that brought him together with Idealab founder Bill Gross. The two Internet junkies became fast friends in 1997.

PRE-ROCK STAR DAYS
Mr. Elkus had spent the previous 12 years managing money for super-rich families and individuals, such as Lee Iacocca. As a money manager, he delved into real estate and leveraged buyouts, as well as the public and private markets. (He knew plenty of Silicon Valley VCs before they were rock stars, because his clients were limited partners in many established Silicon Valley venture funds.)

In a tiny office, where he says he couldn't help but stand more than six inches away from Mr. Gross, Mr. Elkus sketched out the concept for ICP on a piece of paper. This new venture would be independent of Idealab, but it would be able to invest in Idealab and its portfolio companies.

Well before Internet mania swept the country, the two Bills positioned themselves to make the most of it. And that they did. Mr. Gross's incubator hatched a brood of successful business-to-consumer (B2C) companies. ICP, in which Mr. Gross is a partner, went along for the ride, raking in fat returns from investments in Idealab's portfolio companies. Out of the five companies ICP has taken public, three -- eToys (Nasdaq: ETYS), GoTo.com (Nasdaq: GOTO), and Netzero (Nasdaq: NZRO) -- were Idealab companies, and of the ten companies ICP has sold, two were created by Idealab, and two were bought by Idealab portfolio companies.

ICP, like Idealab, has made a mint. Just how much, Mr. Elkus won't say. Its record isn't perfect, however. Three of its startups have failed (Mr. Elkus won't reveal the names), and one (X.com), laid off staff and shut down part of its business in November. Idealab itself, which ICP owns a stake in, backed out of a planned IPO in October, after six months in registration.

Thanks to its financial structure, ICP has the flexibility to look beyond Idealab's hatchlings. Clearly, it made a killing by betting on a number of Idealab's B2C plays, but ICP wisely starting reducing its exposure to B2C in late 1999, when B2C valuations spiraled into the stratosphere. Of the firm's last 18 deals, 15 lie outside the consumer Internet space. It may now be in better shape than the very incubator that made it famous.

YOUNG AND FREE
Mr. Elkus contends that ICP is in a better position than many of its VC competitors because it is less than three years old. "To some extent being a newer fund is a competitive advantage for us because we have fewer legacy investments to shore up," he says. It's hard to argue with that thinking. A lot of the larger funds are slowing down. They say they're getting more selective with the deals they do, but many of them just didn't have the liquidity events they expected, and now they have to do damage control.

Mr. Elkus is by no means suggesting that ICP was smarter than other VCs. A lot of it had to do with being at the right place at the right time. The fact that ICP hasn't written off a single investment out of 26 deals in its first fund ($105 million) "isn't because we're the smartest people on earth," he says. "We were in an environment that was magical."

He adds that it's unrealistic to expect ICP's second fund ($364 million) to do as well as its first. "That's just not going to occur," he says. "You know the rules: you expect to have half of your companies basically go completely out of business."

For now, ICP doesn't have to deal with a file cabinet of troubled portfolio companies. In fact, because it has had so many liquidity events, four out of its five partners (excluding Bill Gross) sit on an average of just four boards. That's remarkable when you consider that many, if not most, of the partners at billion-dollar funds sit on more than ten boards apiece.

That "free" time is going to allow ICP to raise its third fund -- for an undisclosed amount -- in the first quarter. It will be interesting to see if fund No. 3 takes just two days to raise and is oversubscribed by $250 million, like fund No. 2, or whether the Idealab name has lost its luster among institutional investors. ICP attracted an enviable list of limited partners in its second fund, including the State of California's public employees' pension fund (CALPERS), the Massachusetts Institute of Technology (MIT), and J.P. Morgan.

With its third fund, ICP plans to continue to focus primarily on early-stage "technology-based companies." That will require a large time commitment -- which it has in ready supply. Its partners could each do one deal per quarter next year and still be sitting on just eight boards each at the end of 2001.

That luxury isn't lost on Mr. Elkus. Although the venture market is in transition, a lot of factors have turned in favor of VCs. For one, entrepreneurs have lowered their expectations on valuations as fewer VCs bid for the same deals.

Second, a lot of the crud is being shoveled out of the market. In the past couple of years, it was very common to start a company and then see a handful of similar companies spring up in a few weeks' time, because VCs were chasing similar ideas, Mr. Elkus says. That's much less likely to happen now that VCs are tightening up.

Finally, the amount of time VCs can spend on due diligence is returning to normal. When the Internet frenzy was at its height, some VCs were inking deals with less than a day of due diligence. If real due diligence had been performed on the raft of dot coms that were funded, many never would have gotten funding in the first place. Now there are so many failures that there are Web sites dedicated to dot-com deaths, an embarrassment to the entire venture community.

Unfortunately, so many VCs have gotten black eyes, some of them seem to be going from one extreme to the other -- once "fund everything," now "fund nothing." That may stave off further shiners in the near term, but it will hurt them -- and entrepreneurs -- over the long haul. Mr. Elkus, who has seen venture capital waves rise and fall before, says giving in to fear would be a big mistake. "The worst thing would be if people get so scared that they're not willing to see the gems hidden in the sand," he says.

Snapshot
COMPANY Idealab Capital Partners
HEADQUARTERS Pasadena CA
FOUNDED 1998
PARTNERS Bill Elkus (cofounder), Bill Gross (cofounder), James Armstrong, Erik Lassila, and William Quigley
CURRENT FUND $364M (raised in September 1999)
TOTAL UNDER MANAGEMENT $469M
FOCUS Early-stage software and communications companies
INVESTMENT CRITERIA Early-stage tech companies that have the potential to become leaders in markets with explosive growth, and that have a strong technology-based advantage
AVERAGE 1ST ROUND INVESTMENT $2M-$20M
NO. OF COMPANIES FUNDED 41
NO. OF EXITS 15
NO. OF FAILURES 3
SAMPLE OF COMPANIES BACKED Aceva Technologies, Carsdirect.com, Cooking.com, eToys, GoTo.com, HealthAllies, InternetConnect, MP3.com, Netzero, Paypal (bought by X.com), Petsmart.com, Realnames, SummitLogic, and Tickets.com
UNSOLICITED B-PLAN POLICY Prefers plans from trusted source.
SEND B-PLANS TO 130 West Union Street,
Pasadena CA 91103
MR. ELKUS'S RESUME Manager (final title), Boston Consulting Group, 1977-1982; CEO, money manager Nathan Todd and Co., 1982-1994; CEO, Zimmerman Capital Group (private investment arm of family that founded Pic 'N' Save, 1982-1991 (ran Nathan Todd and Zimmerman Capital at same time); cofounder/managing director, Iacocca Capital Partners (now known as Klein Investment Group), 1994-1997; cofounder/senior managing director, Idealab Capital Partners, 1998-present.
MR. ELKUS'S EDUCATION MIT, bachelors in mathematics, 1973; MIT Sloan School of Management, masters in management, 1973; Harvard Law School, law degree (magna cum laude), 1977
MR. ELKUS'S BOARD SEATS GoTo.com, Realnames, Cooking.com, HealthAllies.com
PERSONAL Married for 22 years with three children. Vegetarian. His father and grandfather were men's clothiers. His grandfather, Nathan "Toddy" Elkus is credited with designing the zoot suit. Founded two Internet discussion groups to help researchers, doctors, and patients learn about celiac disease; they now have 4,000 subscribers in 40 nations.



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