One

Unlonely

Back in the days when rock and roll lyrics were intelligible, the rock band Three Dog Night had a hit single with a memorable line: "One is the loneliest number that you'll ever know." In venture capital circles, the opposite is true: "One" is the handle applied to an investment that performs spectacularly well � so well, in fact, as to guarantee that venture capitalists who produce "Ones" will never be lonely again. Indeed, they might never find a moment of peace again, such is the ardor with which institutions clamoring to invest more heavily in "private equity" lust after vc's who've racked up "Ones."

Welcome Return

Definitionally, a "One" is an investment by a venture partnership in a private company that returns 100% of the capital committed to the partnership. For example, if a venture partnership has committed capital of $100 million, it will not score an elusive "One" unless one of its investments generates $100 million of wealth for the partnership via one of the three means by which venture funds typically harvest gains: (1) the distribution to limited partners (LPs) of shares in the original venture following its initial public offering (IPO), (2) the distribution to LPs of shares in a different company following the venture's acquisition in a stock swap, or (3) the distribution to LPs of cash following the venture's acquisition in an all-cash deal.

Changing Emphasis

In "the old days" (i.e., prior to the mid-1990s), the first exit strategy listed above (IPO heaven) was what most vc's and virtually all LPs dreamed about when they put their heads on the pillow each night. These days, the second exit strategy (swapping fattened geese for stock in public entities) is the favored road to riches, the IPO market having grown twice-shy after having been more than once-burned by shaky deals foisted on Wall Street by Silicon Valley and other hotbeds of venture investing. Ironically, the shift from IPOs to stock swaps as the exit strategy of choice for venture partnerships has made the posting of "Ones" more common than it used to be. Why? Because the lofty valuations commanded by publicly traded technology stocks provide acquisition-minded managements with irresistible incentives to use such shares to acquire venture-backed enterprises that might ultimately have gone public themselves in a more receptive IPO environment.

Good News, Bad News

The good news for LPs is that the consideration flowing back to them from vc commitments increasingly takes the form of shares in seasoned enterprises (versus newly public ones). The bad news is that the shares received via exit strategy #2 typically entail sales restrictions. While some venture capitalists will not distribute shares to LPs unless restrictions have lapsed, pecuniary incentives often induce vc's to distribute shares that remain restricted in some manner. This is especially true when the timely distribution of restricted shares will enable a general partner to lock in a coveted "One": the returns reported by venture partnerships are based on the market value of distributions on the date they are made, regardless of the distributions' subsequent performance. This is perhaps the least-worst way of measuring venture results, but it does produce a troubling gap between returns trumpeted by the vc community on the one hand and the returns realized by its outside investors on the other.