Tech Startups Break Venture Capital Habit.

THE Wall Street Journal ran what must have been the world's first dramatically interesting news story Sept. 15 about convertible bonds. The news: New technology companies, on their brief journey from conception to selling public stock, no longer rely exclusively on venture capital.

In the past few months, several optical networking companies have raised capital by issuing bonds that can be converted into equity shares, at anything from 100 percent to 150 percent of the initial public offering price -- assuming, of course, that the company ever issues stock.

By throwing in this strange, notional equity kicker, a company called Kestrel Solutions Inc. borrowed $125 million at an interest rate of 5.5 percent. Another, Cyras Systems Inc., raised $150 million at 4.5 percent. In effect, these companies have sold extremely expensive call options on their future shares -- shares that may never exist.

Investors "know that their ability to get a big stake in (an exciting) IPO will be difficult," Brooks Harris, head of convertibles at Morgan Stanley Dean Witter & Co. told the Journal. "So they may be willing to buy this security at a premium rather than not have the ability to invest at all."

The Journal used this story to illustrate the fantastic appetite of investors for optical networking (it speeds up the internet), and that's fair enough. But these new convertibles tell you even more about the fantastic envy that investment bankers feel toward venture capitalists

Power shift

One of the great themes of the technology boom has been the financial power shift westward. During the Internet boom, Wall Street bankers got sort of rich, and Silicon Valley VCs got really rich. Wall Street bankers flew hundreds of thousands of miles a year and spent weekends in a cube farm; VCs cycled a few miles to work in the California sunshine, and jogged during lunch.

For a long five years, Wall Street bankers have been like trout, wishing they were salmon, longing to make the long run upstream, to spawn Ciscos and Amazons.

They mailed their resumes to Silicon Valley and heard only silence. They opened their own venture capital divisions, and succeeded, mainly, in proving that being a VC wasn't as easy as it looked. Finally, they went back to their cube farms and had some version of the following conversation:

"What do we do for a living?"

"We bestride the world as a colossus."

"No, you moron, that's what we did in the '80s. Now we sit and watch as VCs bestride the world as a colossus. So, what's left for us to do?"

"Well, we still create and sell securities."

"Exactly. So what kind of security can we make and sell that would steal business from those bastards in Silicon Valley?"

"Well, we could sell the IPO before the IPO ever happened. That'd screw 'em."

"Sure, but who'd buy it?"

A lot of mutual fund managers, as it turns out. The general view, undimmed by the slide in the stock prices of internet companies, is that the biggest gains in investing come from handing over capital to companies at the earliest possible moment. This is a venture capitalist-style judgment, but a lot of money managers clearly feel qualified to make it.

As a result, the investment bankers have moved into the VCs' life. It was only a matter of time. The second rule of life is that if investment bankers don't get invited to the party, they break down the door. (The first rule is that if you find yourself on the other end of a deal from both investment bankers and Hollywood studio executives, you're screwed.)

Cheaper capital

The ambition of investment banks is a marvel to behold; and in this case, we should all be grateful for it. The effect of the new convertibles -- which, I'll bet, signal the beginning of a trend of unlikely capital being funneled by Wall Street into every hot, new technology -- is to make capital even cheaper for entrepreneurs, and to render them even less dependent on the VCs than they currently are.

The explosion in the number of VC dollars has forced the VCs to raise the prices they pay for pieces of new technology businesses. But they don't control these new convertibles -- the investment bankers do. The Wall Street convertibles promise to open the floodgates even wider, and cause even more capital to flow into new, unproven technology companies. This is great for entrepreneurs, bad for financiers, and especially bad for the venture capitalists.

Michael Lewis, the author of "Liar's Poker" and "The New New Thing," is a columnist for Bloomberg News.