Excerpts from the book

A History of Silicon Valley

Table of Contents | Silicon Valley History pages | Purchase | Correspondence
(Copyright © 2010 Piero Scaruffi)

 

13. Helpers: Lawyers and Investment Bankers   (1970-2000)

by Arun Rao

THESE ARE EXCERPTS FROM THE BOOK A History of Silicon Valley

 

The Most Maligned Group

One underappreciated aspect of Silicon Valley was the infrastructure of professional “helpers” that supported startups. Between the large corporate engines, the nimble entrepreneurs, and the legions of venture capitalists, stood the workhorse professionals who supported the smooth functioning of the Valley.  These were the corporate lawyers and investment bankers (also accountants and journalists, who will not be covered in this chapter). The professionals were sometimes maligned, and as the venture capitalist Tom Perkins once (perhaps unfairly) referred to investment bankers: “[T]hey are a necessary evil.”

For the lawyers, a handful of specialized law firms dominated the Valley. First and pre-eminent was Wilson Sonsini Goodrich & Rosati, as it was the largest high-tech law firm in the Valley. Next came a handful of firms such as Cooley, Fenwick and West, and Gunderson Detmer. Some notable failures were Brobeck Phleger & Harrison and the Venture Law Group.

The investment bankers have had a tougher time, as most of the boutique Silicon Valley bankers have gone bust or folded into larger enterprises. This includes firms like Montgomery Securities, Robertson Stephens, and Hambrecht and Quist. In 2010, the initial public offering (IPO) and mergers and acquisition (M&A) business in Silicon Valley is dominated by the large broker-dealer banks such as Goldman Sachs, Credit Suisse, Morgan Stanley, Deutsche Bank, and so on.

 

Wilson Sonsini Goodrich & Rosati

In 2010, Wilson Sonsini Goodrich & Rosati was legal counsel to more than 300 public and 3,000 private companies, representing firms such as Apple Computer, Hewlett-Packard, VA Linux Systems, Novell, Netscape Communications, and Micron Technology. The firm also served investment banks and venture capital firms that financially support both technology and other companies. Based in the heart of Silicon Valley with a satellite office in San Francisco, the law firm also operated offices in other hi-tech centers such as Austin, Texas, McClean, Virginia, and Kirkland, Washington. The firm’s gleaming glass-walled offices at 650 Page Mill Road are affectionately referred to as the “Death Star” by its competitors and Stanford neighbors.

If every institution is the lengthened shadow of one person, then Wilson Sonsini the law firm could point to the name partner Larry Sonsini. He was perhaps Silicon Valley’s most feared and sought-after lawyer and acted as corporate consigliore to many CEOs. He was a soft-spoken and disciplined man, often dressed nattily in dark Italian suits. Sonsine worked in the Valley’s environment of frenetic shouters wearing chinos or blue jeans, t-shirts or polo-shirts, and often flip-flops. In contrast, Sonsini’s papers would be arranged neatly in evenly-spaced stacks across his office desk. During his 40 plus years as a lawyer, Sonsini helped to bring public many of the leaders of the technology boom, including Netscape Communications, Pixar, Google, Apple, and SUN Microsystems.

Sonsini graduated from the UC Berkeley undergraduate and law school programs and he joined McCloskey Wilson & Mosher (founded 1961). He became its first associate in 1966. His mentor was John Wilson, then 50, who after a distinguished legal career in the East had moved to the Valley in 1956. The firm’s location near Stanford University helped it represent companies formed from research conducted there. By 1966 the firm had established ties with some key players in the new venture capital field, including Laurance Rockefeller, Davis and Rock, and Draper, Gaither and Anderson. Wilson was even involved in the formation of the Mayfield Fund and was a part-time partner there for a while.

Wilson Sonsini‘s legal business model was to represent entrepreneurs and startups first, venture firms and banks second. Both Wilson and Sonsini wanted to continue to represent their clients as they grew, rather than handing them off to larger firms when they went public, which was common practice. Or as Sonsini said, “we started to develop the recipe for how to build companies… I was becoming a piece of the recipe.”

In 1969 the partners created WM Investment Company to take advantage of stock options that some of its startup clients offered instead of cash for payment of services. It was a way of dealing with a very practical problem of poor clients. Many other Valley law firms eventually adopted this practice as a way to participate in their clients’ long-range success. This practice, however, created a potential for conflicts of interest. For example, if a lawyer holds stock in a client company and then has to decide whether the client needs by law to disclose information that may cause its stock price to fall, the lawyer’s judgment could be clouded. Also, some partners had access to deals that others didn’t, causing a partnership conflict. So in 1978 Wilson Sonsini set up WS Investments, a fund designed to manage both problems. Each partner’s pay would automatically be docked to create the fund. Deductions were mandatory and so each partner would have pro rata equal stakes in every company. Typical investments were in the $25,000 to $50,000 range, and payouts could be large (the Google investment was worth nearly $20 million after the company’s IPO in 2004).

In the 1970s the law firm gained new partners and a new name. John B. Goodrich, a tax expert, joined to start the tax department in 1970. In 1971 Mario M. Rosati was recruited to build the trust and estates practice. After McCloskey left to enter politics in 1973, the firm changed its name to Wilson, Mosher & Sonsini. Eventually in 1978 the firm assumed its current name: Wilson Sonsini Goodrich & Rosati. Note that the tax and trust and estates departments were strategic additions to serve startups and their founders.

The event that marked Wilson Sonsini‘s arrival on the national business stage was its representation of Apple Computer in its IPO in 1980. It was the largest IPO since Ford Motor Company’s in 1956, and the notion that two local Palo Alto firms (Wilson Sonsini and Fenwick) would handle it was a big deal. While the 1970s were the time of semiconductor companies, the 1980s brought Apple and a range of computer companies (hardware, peripherals, software).

In 1984 the firm entered the mergers and acquisition advice business of providing mature technology firms with counsel. The firm had helped ROLM Corp. get started in 1969 and had handled its IPO in 1975. Then Larry Sonsini represented ROLM when IBM acquired it for $1.8 billion. The ROLM transaction implied the firm needed more manpower if it were to provide a full range of legal services. By 1986 it expanded to 97 lawyers, sometimes by lateral hiring of mature attorneys from rival law firms. Driven and hard-headed entrepreneurs appreciated Sonsini. TJ Rodgers, the founder and CEO of Cypress Semiconductor, noted that he didn’t take orders well but he liked Sonsini for being professorial and nonjudgmental. Sonsini’s attitude was “you can choose to do this, you can choose to do that, and these will be the consequences.” An entrepreneur was not being forced or pushed into anything. Instead Sonsini explained why a frustrating, arcane, and inefficient system of laws made sense and should be followed.[25]

The 1980s were a good time, as a mini-bull market kept the firm busy with a string of technology IPOs. By 1988, Wilson Sonsini‘s average profits per partner reached $430,000, much more than any San Francisco firm and outpacing the nearest competitor by $100,000, according to The Recorder, a San Francisco legal newspaper. Sonsini personally found the Valley to be unique because of lateral movement for startup employees (going to one company while looking to work for another), plus the equity compensation culture (due to US tax policy in that granting of stock options isn’t a taxable event). Sonsini also opined on the failure culture: “Failure is not a stigma. The fact that you started an enterprise and failed at it probably makes you more valuable as an entrepreneur.”

Silicon Valley’s lawyering style is less adversarial and more cooperative than normal. While many East Coast lawyers are in the business of protecting wealth and fighting hard for their clients, most Valley lawyers understand the importance of cooperation as all transactions are repeat transactions (the Valley is a small environment). A scorched earth strategy is a poor one, as the prevailing Valley sentiment is to make the pie larger, rather than the traditional view of dividing a fixed pie. For many businesses, lawyers are combatants. However in the Valley the focus of business is to create wealth. Neither lawyers nor clients want to spend weeks arguing with theatrics or threats.

The 1990s technology boom brought even more clients, deals, and conflicts. For example, in 1995 Wilson Sonsini represented its client Seagate when it acquired Conner Peripherals, another client. The CEOs had to sign a conflict-of-interest waiver. With the healthcare and biotechnology industries expanding, Wilson Sonsini represented several life science firms in the 1990s, including Abgenix, Cardiac Pathways Corporation, Cell Genesys, and Vivus. Non-tech clients included Home Depot and Monaco Coach Corporation. The decade ended with Wilson Sonsini doing 118 initial public offerings in 1999 (representing both companies and underwriters) - the most of any law firm in the nation. The firm bulked up to handle the workload, peaking in size at close to 800 lawyers in 2000. Other national law firms popped up, opening 40 satellite offices. It was a bad time, as Wilson Sonsini partner Boris Feldman admitted “it was a period of raw greed.” Restrained greed was always an important component in the Valley, where the sense was if you built a good company, you’d be rewarded for it. But during the Tech Bubble, people forgot the element of building value and went mad. Feldman felt the “values in the Valley were, if not corrupted, then certainly strained.”[26]

In 1999 and 2000, Sonsini later admitted it was “somewhat of a practice” for Valley lawyers to insist on getting investment opportunities in their startup clients as a pre-condition of representing them. Even some Wilson Sonsini lawyers did this. Yet after the peak, the Tech Bust was sobering, as Wilson Sonsini had to lay off dozens of lawyers, along with the rest of the Valley.

The aughties were tough as Larry Sonsini got caught up in the HP boardroom scandal in 2005 and the corporate options backdating scandal in 2006. While he was found to have clean hands in both situations, they rocked the Valley. Also, while Sonsini sat on nine public boards in February 2002, by 2010 he was down to just one (Echelon Corporation). He had come to believe that the presumption should be against sitting on public boards, to keep boards more independent and lawyers with fewer conflicts.

 

Other Big Silicon Valley Law Firms

The other important Silicon Valley law firms are Cooley, Fenwick and West, and Gunderson Dettmer.

Cooley was founded in the 1930s when Arthur Cooley and Louis Crowley started a law partnership in the Humboldt Bank building in San Francisco. Later important partners were lawyers such as Fred Supple, Bill Godward, Rowan Gaither, Ed Huddleson, Gus Castro, and Sandy Tatum. The firm’s name has changed many times, and today the firm simply goes by Cooley LLP. In 2010, Cooley had some important clients such as Google, eBay, Facebook, NVIDIA, Tivo, Brocade, Bluetooth, Adobe Systems, and so on.

In 1958, Cooley formed Draper, Gaither and Anderson, the first venture capital partnership to be organized on the West coast. The Firm also formed Raychem in 1957 and National Semiconductor in 1959, two early technology stars. Later Cooley took Genentech public in 1980 and Amgen in 1983; they were the largest biotech companies by market capitalization.

As Cooley was a San Francisco-based firm, in 1980 it opened a second office in Palo Altop In 1992, Cooley took Qualcomm public and soon opened an office in San Diego. Cooley eventually opened offices in other technology centers like Boulder (Colorado), Reston (Virginia), Boston (Massachusetts), and Seattle (Washington). It eventually merged in the fall of 2006 with Kronish Lieb Weiner & Hellman LLP, a New York firm with bankruptcy, tax, and complex commercial and white-collar litigation practices.

Fenwick and West was founded by four attorneys who moved to Palo Alto in 1972. The firm incorporated Apple Computer in 1976 and took Oracle Corporation public in 1986. It was involved in major M&A transactions including the largest Internet merger in history (VeriSign’s $21 billion acquisition of Network Solutions) and the largest software merger in history (Symantec’s $13 billion acquisition of Veritas Software). By 2010, Fenwick and West was the 2nd-largest law firm headquartered in Silicon Valley.

Genderson Dettmer was a smaller, boutique firm, but many angels in the Valley, such as Chris Dixon, preferred it to the large firms due to its flexibility and lean structure. That contrasted with two notable law firm failures:  Brobeck Phleger & Harrison and the Venture Law Group.

Brobeck was formed in 1926 and had traditional clients, such as Wells Fargo, for many years. Yet during the Tech Boom, its lawyers choose to focus on serving technology clients (neglecting anti-cyclical business like bankruptcy and litigation), taking equity instead of cash, spending lavishly on marketing (advertising on TV), and building a fancy headquarters. The firm’s revenues jumped from $214 million in 1998 to $314 million in 2000, when the firm became top-heavy with 754 attorneys (but a profits-per-partner figure of more than $1 million a year). As the firm started to lay off staff in 2002, key lawyers jumped to other firms and took their clients with them. What was left was a large building with few partners and lots of debt, which ended in a dissolved partnership.

The Venture Law Group was formed in 1993 to serve only startups. The firm prospered during the Tech Boom as it took equity stakes and cashed out big. In 1999, the firm’s equity investments generated more than $30 million, and in 2000 investments generated more than $100 million. The firm’s business model was hence rooted in equity compensation and not cash. From 2000 to 2001, revenues fell from $64 million to $54 million, and even more in 2002. Eventually, the Venture Law Group was absorbed by a larger, more traditional San Francisco law firm, Heller Ehrman (which incidentally also went bust during the 2008 financial crisis).

 

Defunct Investment Banks of Yore

Sadly the history of investment banks in Silicon Valley was one of failure. Investment bankers were essential to the Valley infrastructure as they help companies scale up from smallish, private venture capital money to massive public equity capital. The investment bankers were essential since under US securities laws and SEC regulations, before an IPO was completed and money raised, a company needed to follow a set of procedures and do a road show, where management met with different groups of investors in cities around the US, to raise capital from the public. The investment bankers (stock underwriters) used the tour to build a book of orders for the company (stock issuer). In good times, the stock was oversold by two or three times. Very rarely did investment bankers have to take on the risk of purchasing the leftover shares of an undersold issue to hold on their own books. Some would argue the most important function of an investment bank was its list of contacts: institutional investors such as pension funds and mutual fund managers on the one hand, and the companies ready for IPOs on the other. Essentially, investment bankers were SEC-licensed gatekeepers and middlemen.

Not everyone was a fan of investment bankers. Tom Perkins believed the term investment banker was misleading. The Wall Street banks didn’t invest or provide basic banking services, rather they just marketed the stock of an IPO like glib salesmen. Perkins wrote that “the term fee-charging middlemen is clearly less attractive, but it’s a much closer to an accurate description of their actual function.” Even at his career’s end, Perkins found investment bankers exceptionally short-term oriented on any given transaction and focused only on their resulting fee. For Perkins, investment bankers were a “necessary evil.”[27]

Perkins’ partner, Frank Caufield, had an even more caustic comment about bankers:  “They have all the self-restraint of lobotomized sharks.”  One must, however, keep in mind the social value of an investment bank. Any growing enterprise needs large amounts of capital that only the public markets can provide. The public equity, corporate structure offers a company and its investors advantages:  i) two layers of limited liability (protecting investors from the liabilities of the company and the liabilities of other investors, while protecting the company from the liabilities of investors); ii) tradable and fungible, hence liquid, stock ownership; iii) a fast way to raise further money through shelf registration and access to debt and commercial paper markets. And investment bankers are the sole gatekeepers for the public equity markets, making sure that both buyers and sellers of stock get a fair deal.

Silicon Valley was historically served by four independent, San Francisco-based boutique investment banks from the 1960s to the late 1990s. Their Wall Street competitors called them the HARM group, though they preferred the moniker of the Four Horsemen: Hambrecht & Quist, Alex Brown & Sons, Robertson, Stephens, and Montgomery Securities. By 2000, each of those firms had been gobbled up by a large, Wall Street bank. This was followed by defections of large numbers of investment bankers and other key employees. There were several reasons the banks couldn’t stay independent: 

§         The big Wall Street investment banks started to compete strongly during the Tech Boom, and they had greater resources to do so. For example, the bigger investment banks offered companies a full array of products for raising money, including loans, bonds and specialized forms of stock. The Four Horsemen focused mainly on traditional stock offerings;

§         Depression-era regulations like Glass-Steagall were removed, allowing commercial banks with large balance sheets to enter the business and outcompete the boutique investment banks;

§         Most of the Four Horsemen sold out before the top of the bubble so their senior partners could cash in, perhaps sensing there was a bubble and that their long-term competitive position was weak.

In 2010, a handful of Wall Street banks, such as Goldman Sachs, Morgan Stanley, Credit Suisse, Deutsche Bank, and so on dominated the Valley IPO and M&A scene. Jeffries Group survived as the only independent bank, but its headquarters were in Los Angeles.

 

The Four Horseman Boutique Investment Banks

The oldest investment bank in Silicon Valley, Alex Brown & Sons, was actually a Baltimore bank started by Alexander Brown and which did an early US IPO, the Baltimore Water Company, in 1808. Eventually the firm moved to New York by the late 19th century to do railroad financings, and it opened up a San Francisco office after World War II. The company had the good fortune to do the IPO of some growth companies of the times, including Microsoft, Oracle Systems, Starbucks, and United Healthcare. Alex Brown & Sons was bought by Bankers Trust in 1997 to form BT Alex Brown. Two years later, in 1999, BT Alex Brown was acquired by Deutsche Bank.

The genesis of investment banking in San Francisco was with Sanford “Sandy” Robertson. Robertson came to California in 1965 as an investment banker for Smith Barney and did early deals with Applied Technology and Spectra-Physics, during which he met Tom Perkins when Spectra-Physics acquired Perkins’ laser company University Labs. However, as Robertson tells it, his co-workers in New York City made fun of his “ray gun company” and he decided to leave and start his own firm, realizing he had no future doing West Coast technology deals for an East Coast bank. So he started Robertson, Colman & Siebel in 1969, raising $100,000 from 8 limited partners, including Eugene Kleiner, and the three principals each put in $100,000 ($1.1 million total). The limited partners brought deals, advice, credibility, and technology knowledge

Robertson’s early deals included the Wangco IPO, a tape drive manufacturer, and in the fall of 1972, the IPO of Applied Materials, which would become a multi-billion dollar semiconductor company. One of Robertson’s proudest moments was introducing Eugene Kleiner and Tom Perkins, by asking them to breakfast at Rickys Hyatt House. The two men instantly hit it off, and Robertson said this was “the best merger I ever did in my life … introducing those two guys to each other and raising their first fund [$8.4 million in 1972].”  In 1971, Thomas Weisel, an Olympic-caliber athlete, joined the firm, which was renamed Robertson, Colman, Siebel & Weisel. Weisel was a quick study and in October 1978, Weisel, the junior partner, pulled off what was described later as a mutiny. Weisel became chief executive of the firm and prompted the departure of Robertson and Colman. Weisel changed the name of the firm to Montgomery Securities.

Montgomery Securities ended up being a dominant boutique investment bank that specialized in the high-tech and health care sectors. Montgomery became the lead banker for high-tech companies like TriQuint, Cyrix, and Quarterdeck. It also reached deeply into the broader market, handling last year’s offering by Avis Rent-A-Car and Guitar Center. The 1990s were good years for the firm, as it more than doubled to 1,400 employees. Eventually Weisel sold the firm in 1997 for a rich $1.2 billion payout to Nationsbank, despite the firm’s meager capital of only about $200 million. A year after the sale, Weisel left to start a new, competing firm named Thomas Weisel & Partners. He recruited several of his highest-ranking colleagues to join and using the sale money to fund the initial operations.

Sandy Robertson was not finished, however, after his ouster in 1978. He went on that year to found Robertson, Colman, Stephens & Woodman along with partners Robert Colman and Dean Woodman (the firm’s name was shortened to Robertson Stephens & Company in 1989). Robertson Stephens and Montgomery Securities would remain fierce rivals for two decades. Just during the 1990s, Montgomery and Robertson Stephens generated more than $11 billion in offerings in which they served as lead managers, easily putting the combined investment banks into Wall Street’s Top 10.

Robertson believed investment banking was a great business, as bankers made strategic, high-level decisions and got to “play God” along with a company’s board. He also pointed out that because there was very little financing in the 1970s, a $1 million deal was the largest. If a startup needed a second financing, it was a washout round at 10 cents to the dollar, and at the third round the entrepreneurs got completely washed out. This forced entrepreneurs to be lean and focus on expenses (all this changed in the fat, 1980s markets).

Robertson Stephens helped bring forward companies like SUN Microsystems, Excite and, in the biotech arena, Chiron. It became a leading underwriter of growth companies in the technology, Internet and e-commerce, health care, retailing, consumer products, and real estate sectors. The firm handled more than 500 initial public offerings over a 30-year period, often using Wilson Sonsini as the corporate counsel. Before being sold, the firm led or co-managed 10 of the top 25 IPO performers in 1997 and 8 of the top 25 IPO performers in 1998. Tech Boom deals included advising Excite on its merger with @Home, E-Trade on its purchase of Telebanc, and WebMD in its transactions with Microsoft and Healtheon.

In June 1997, a long tale of sales began as the partners sold Robertson Stephens to BankAmerica for $540 million. The combined firm would operate as BancAmerica Robertson Stephens for approximately 11 months. In 1998, BankAmerica agreed to a merger with NationsBank, which had recently become the parent company of arch-rival Montgomery Securities. The significant internal tensions between Montgomery and Robertson Stephens led to the sale of Robertson Stephens to BankBoston in 1998 for $800 million, a nice profit for BankBoston. Shortly after the sale of the firm to BankBoston, Sandy Robertson left the firm and was succeeded by COO Bob Emery. Robertson Stephens changed hands again the following year when Fleet Financial merged with BankBoston in 1999 to form FleetBoston Financial. As the technology banking business became more competitive due to the major Wall Street banks, Robertson Stephens held its own and completed the underwriting of 74 IPOs with a total value of $5.5 billion between 1999 and 2000.

By 2001, Robertson Stephens was suffering from the bust after the dot-com bubble due to a lack of interest in new technology IPOs and a lack of companies well suited for IPO. Robertson Stephens had a net loss of $61 million in 2001, compared with a net profit of $216 in 2000 (revenue had dropped from $1.56 billion to $543 million). Fleet put Robertson Stephens up for sale in April 2002 and struggled to come to terms with a buyer, as many analysts thought the firm was worth $100 million at most. Senior executives of Robertson Stephens pushed hard for a potential management buyout. However, the deal talks ended in acrimony as Robertson Stephens’ executives didn’t want to give up their guaranteed revenue-sharing pay from previous years. In July 2002, the Fleet team in disgust decided to shut the bank down, firing nearly 950 people in a fast liquidation.

The final horseman in San Francisco was Hambrecht & Quist (H&Q), founded by Bill Hambrecht and George Quist in 1968. H&Q underwrote IPOs for Apple Computer, Genentech, and Adobe Systems in the 1980s. In the 1990s, it also backed the IPOs of Netscape, MP3.com, and Amazon.com. Competition in the investment banking industry in the late 1990s limited H&Q’s growth potential, so in 1999, Chase Manhattan Bank acquired H&Q for $1.35 billion. The firm was renamed Chase Securities West and is currently part of JPMorgan Chase. After leaving H&Q, Bill Hambrecht popularized a Dutch auction model allowing anyone, not just investing insiders, to buy stock in an IPO. Among the companies that adopted this model were Overstock.com, Ravenswood Winery, and Salon Media Group. Most famously, Hambrecht’s new firm nabbed a role co-managing Google‘s large IPO, by persuading the founders to try a Dutch auction method.

 

Surviving Investment Banks

The Silicon Valley investment banking scene was dominated by the big Wall Street investment banks in 2010. Thomas Weisel stayed independent till early 2010, when Stifel Financial Corp. acquired it for $318 million. Stifel participated in nine tech, media, and telecom deals from 2005 to 2009, compared with Weisel’s 96. While the combined company, with estimated revenue of $1.6 billion, had research coverage on more US public companies than any Wall Street firm (1,143), its main office was not in the Valley.

Perhaps the last remaining independent bank was Jeffries Group, founded in 1962 in a telephone booth outside the Pacific Stock Exchange in San Francisco, by Boyd Jeffries. Jeffries was more of a niche broker than an investment bank for a long time, being acquired by IDS and then become independent again and a public company in 1983. It specialized in junk bonds and the oil and gas sector for a while. The firm only became a true investment bank for startups and small companies in the 1990s, under the new CEO Frank Baxter. The number of equity analysts grew from 0 to 38 in 1993, and revenue from investment banking jumped 127%. Sandy Robertson said in the late aughties: “There is a hole in the marketplace where the Four Horsemen have gone. Jefferies has a chance to fill it. They always had great trading and great distribution. Now they got the whole puzzle.”

 

 



Table of Contents | Silicon Valley History pages | Purchase | Correspondence
(Copyright © 2010 Piero Scaruffi)