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Silicon Valley's single degree of separation

March 20, 2014: 6:43 AM ET

The clubbiness of the tech hub is what makes it work. But what if it's at the expense of the startups?

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FORTUNE -- Some call it an ecosystem; others call it incestuous. In Silicon Valley every prominent player is just an adviser, an investor, a co-founder, an acquirer, or a director away from another. It's an industry worth trillions that operates like a small town.

But to the professional meddler -- that is, activist investor -- a tight-knit community suggests something else: conflicts of interest.

That's the criticism that corporate raider Carl Icahn lobbed last month after he grabbed a 2.2% stake in eBay (EBAY). When his initial suggestion for the company to spin off its lucrative payments subsidiary, PayPal, was rebuffed by its board, he took the conflict-of-interest approach, targeting the prominent Silicon Valley investor Marc Andreessen, who serves as an eBay director. "I've never seen worse corporate governance than eBay," Icahn groused to CNBC's Andrew Ross Sorkin.

MORE: eBay's John Donahoe talks Icahn

At issue is eBay's 2009 sale of a majority stake in Skype to a group of investors that included Andreessen's firm, Andreessen Horowitz, for $1.9 billion. Less than two years later, those investors sold Skype to Microsoft (MSFT) for $8.5 billion, earning a healthy return. Icahn also called out Scott Cook for sitting on the boards of eBay and Intuit (INTU), which "share the same long-term common strategic goal to build strong payment-processing businesses." (For more on Icahn, read Dan Primack's column.)

However the eBay feud ends, Icahn's accusations shine a spotlight on Silicon Valley's web of powerful connections. Andreessen, for example, also sits on the boards of Hewlett-Packard (HPQ), Facebook (FB), and seven other companies. Heavyweight investor Peter Thiel sits on the boards of Facebook, the data analysis firm Palantir, and a half-dozen others. And Forest Baskett of New Enterprise Associates sits on an eye-popping 17 boards.

About one-fifth of all corporate directors in the Fortune 500 sit on more than one board, according to 2010 research by G. William Domhoff. But it's standard practice for venture capitalists to join the board of a company when they lead an investment round, and typical for them to do a handful of deals each year. Do the math, and the possibility of double-digit board appointments is not surprising.

The effect of this practice -- call it board-whoring -- isn't usually a problem with small, early-stage startups trying to gain their footing. But it can become an issue when those tiny startups turn into large public entities with billions of dollars of shareholder money at stake. In the technology industry, a convergence of strategies can occur almost overnight. Which is why the social network Facebook, the search giant Google (GOOG), and the computer maker Apple (AAPL) all find themselves vying for the same person's mobile messages today.

MORE: Five management lessons from Ben Horowitz

"Human beings tend to be unable to estimate how biased they are," says Jean-François Manzoni, a professor of management practice at Insead, the French graduate business school. "Research on ethics and decision-making shows fairly clearly that even minute incentives that one has in the outcome of a decision can have significant impact on people's decision-making."

Volume compounds the problem. According to PitchBook Data, the 25 investors with the most board seats share among them almost 400. With each company seat demanding between 20 and 40 days of work a year, according to Manzoni, it can be difficult to justify so many appointments.

No wonder activist investors are drawn to the technology industry.

This story is from the April 7, 2014 issue of Fortune

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