Failure of VC investments could spell trouble for start-ups
BY MATT MARSHALL
Mercury News
Dozens of Silicon Valley companies that jumped on the venture capital
bandwagon last year are now paying for it in failed investments --
raising fears about the future of start-ups they've been funding.
In the wave of market euphoria that began in 1999, a growing number
of companies -- including blue-chips like Hewlett-Packard, Dell and
Oracle -- started venture branches or aggressively stepped up venture
funding. Corporate investors accounted for almost a fifth of venture
capital last year.
But now the cost is becoming clear. As investments have crashed in a
market no longer receptive to IPOs, many companies have written off
millions -- in some cases billions -- of dollars. And some experts fear
these companies will turn the funding spigot down or even off -- which
could spell ruin for hundreds of start-ups in the Valley and across the
nation who depend on them.
Take Eazel. The company makes Nautilus software, a
desktop-management platform for the GNU/Linux operating system,
and is working with Dell on a line of Linux-based computers.
But faced with a shortage of venture capital funds, Eazel laid off 40 of
75 employees last month -- including marketing and sales staff needed
to bring its fledgling product to market.
Eazel CEO Mike Boich hasn't given up hope for funding, and notes
that corporate venture capitalists aren't to blame any more than other
VC firms in the funding delay. However, his firm relied heavily on
corporate investors, including Dell, in its earlier round of financing.
``They're more cautioned and more disciplined,'' Boich says of the
corporate investors. ``In 2000, it was hard for them to do any wrong.
We didn't have to make an air-tight case that our company was a
strategic benefit to their company. Now that's changed.''
The corporate pullout has happened before. Corporations stepped up
their venture investments during economic booms ending around 1974
and 1987, according to David Barry, editor of the Corporate
Venturing Report. Both times they fled when the stock market turned
downward. ``Most of them went `bye, bye,' '' he says.
But this time, corporate venture capital makes up a greater portion of
the industry, and its departure would be even more painful. In 1994,
corporate venture capital made up only 4 percent of total venture
capital investments. In 2000, that number was up to 17 percent.
About 350 corporations have a unit dedicated to venture capital or
make regular investments -- up from about 100 three years ago,
according to Barry.
Now the losses are coming in.
HP announced last week that its portfolio lost more than half of its
worth, sinking $365 million to $310 million. Dell's portfolio dropped
to a value of $1 billion, about half of what it was worth about a year
ago.
Compaq's venture arm recently was forced to write down $1.8 billion
in the fourth quarter. ``Corporate investors will likely become more
conservative and invest less,'' says Brian Bonazzoli, director of
Compaq's corporate development.
It is hard to tell how much corporations are investing or losing on their
investments, because accounting rules don't force them to break out
venture results. Still, some companies have clearly slowed their
investments.
Oracle, a relative newcomer, made a single investment between Jan. 1
and March 16, according to VentureWire -- down from the pace set
last year.
Intel, which has a longer history of venture investments, says it still
aims to invest $1.3 million into start-ups, the same amount as last year.
Intel spokesman Robert Manetta says it's harder now partly because
investing partners -- the venture capital firms that specialize in ferreting
out investments -- have little appetite for finding new deals.
``It's not for lack of trying,'' says Manetta. ``We're finding a lot of VC
firms are pulling back and tending to their own companies.''
While Manetta says Intel's investments were always strategic --
staying up with technology trends, for example -- Intel is hard-placed
to justify investments in companies like eToys, which recently closed
its doors.
And Intel can't shrug off venture capital as a side show to its business.
Last year, Intel invested a relatively small $1.3 billion of the company's
total revenue of $33.7 billion. But it realized $3.8 billion in gains from
its VC branch -- more than a third its entire $10.5 billion in operating
profits.
Intel now says that it realized no VC gains for the most recent quarter,
compared to $2.6 billion in operating income from its other
operations.
Critics say it is difficult to invest strategically and make money too.
``It is not per se incompatible, but it's damned difficult,'' said Charlie
Walker, an venture capitalist with JPMorgan Partners. ``The vast
number of these investments end up with returns that are suboptimal.''
Indeed, some companies have been hurt by their investment strategies.
Dell started making formal venture investments with Red Hat Software
in March 1999, and has since made more than 70 investments in other
start-ups.
Dell's investments in five companies that went public last spring before
the Nasdaq's dive are now worth just $43.6 million -- less than a
fourth of what Dell pumped into them. Another company, Digital
Entertainment Network, recently closed its doors.
Dell has contributed to its own problems, some insiders say. Priding
itself on its fleet-footed style and can-do attitude, Dell's venture branch
made investments rapidly without regard to the company's overall
business strategy. Soon, other Dell units found themselves doing
business with competitors of the companies that Dell's venture branch
invested in.
That happened with LivePerson, a New York company that allows
e-commerce sites to have online conversations with customers at the
point of sale.
Dell invested in the company in early 2000, buying up 9 percent at a
time when it was valued at $95.2 million, public documents show.
Since then, however, the company has gone public, and its value has
plummeted to $10.58 million -- wiping out more than 80 percent of
Dell's original investment.
Worse, Dell has reportedly stopped using LivePerson's products.
Instead, just as LivePerson was going public, one of Dell's business
units began using a competing product, that of Foster City's FaceTime
Communications, in which Dell had no investment.
Dell reportedly even requested that FaceTime's chief executive, Glen
Vondrick, refrain from talking about their business agreement, for fear
of embarrassing Dell's venture capital arm. Vondrick concedes: ``Dell
has been reluctant for us to share news about a lot of our products,
even though they love us.''
Dell spokesman, John Thompson, would not comment on its dealings
with LivePerson or FaceTime. However, he says the company did not
view such arrangements as conflicts. ``We treat our investments just
like we do any other business relationship,'' he says.
Vondrick of FaceTime says his own corporate investor, Compaq, has
been helpful. Having big corporations on board as customers and
investors, he says, assures other customers that the company is
unlikely to go out of business anytime soon.
Still, he says, corporations are likely to do more due diligence in the
future before they invest: ``Corporate investors are going back to ask
the traditional question: Is this a strategic technology?''
Contact Matt Marshall at mmarshall@sjmercury.com or
(408)920-5920.
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