New Signs of Life Begin to Show for Venture Investors
By Mark Veverka
Barons.com
_________________________________________________________
<<What start-ups fortunate enough to get funding during the current economic doldrums will emerge as the tech titans of the 21st century? What neophytes will be the darlings of a rejuvenated IPO market in 2003 or 2004?
The questions aren't as absurd as one might think. There are still billions of dollars out there on the sidelines looking for cutting-edge technology companies. Of course, plenty of venture capitalists are preoccupied with tidying up the messes they made during the past few years. Indeed, while often not admitting to it in public, many venture firms are marking their funds down to zero, meaning they are essentially declaring to their investors that they blew all of their dough with little to show for it.
And if they aren't folding their tents, they are frantically performing triage on those portfolio companies showing signs of a pulse. That means too many VCs are now actively running the day-to-day operations of their bubble-era investments instead of beating the bushes for the next new thing.
While few venture backers would be so insolent as to claim that their firms side-stepped the mania altogether and don't have some incredibly silly-looking business models in their portfolios, the fact remains that some firms are deeper in the post-crash quagmire than others. Thus, for those VCs with the time, money and fortitude, now may be a better time to invest in early-stage companies than in years.
"We feel extremely strongly that this is a great time to be in the private equity business. Pre-investment valuations are down, terms are much more favorable to investors, and there's time to do deep due diligence," says Thomas Blaisdell, a partner at Doll Capital Management in Menlo Park, California.
What's more, the entrepreneur wannabes have to a large extent gone back to banking, consulting and business school. That means that mostly only serious -- sometimes serial -- entrepreneurs are the ones left pitching during these dampened economic times, Blaisdell maintains.
Blaisdell's boss and his firm's founder, Dixon Doll, is a 30-year veteran of the telecommunications industry. While working on his master's and doctoral degrees at the University of Michigan in the mid-'Sixties, Doll had the good fortune of having a mentor with vision. "I had a professor there that said data communications was going to be an area of significant growth," deadpans Doll, who went on to become an IBM networking consultant for much of the 'Seventies.
Some 30 years after that fateful nudge, Doll recognizes that the best is yet to come. The engineer-turned-investor founded his venture firm in 1996 after an eight-year stint at Accel Partners, also in Palo Alto, where he launched that firm's telecommunications fund. Doll Capital now has three funds with a total of more than $1 billion under management. Robertson Stephens co-founder Sandy Robertson is an advisory board member. The firm's first fund is ranked in the top quartile of all private equity funds invested in 1996-97 and produced a net return of 100%, having made investments in Foundry Networks and IPivot, which was acquired by Intel.
One of the reasons Doll is so optimistic about the current climate is that with so many companies going sneakers-up and cutting their payrolls, the talent pool for top managers is the best he has ever seen for private companies trying to hire top-notch CEOs.
Indeed, bidding wars among early-stage investors have ceased and management talent is plentiful, but the current pragmatism on Sand Hill Road is actually being driven largely by the hope that history will repeat itself. As it turns out, many of the technology companies funded during the economic downturn of 1990-91 went on to become leading public companies of the past decade.
To solidify that point, Doll and Blaisdell researched start-ups that were spawned during that period and came up with a list of companies that were deemed big winners -- if not always for shareholders down the road -- for early stage investors.
Their list includes Bay Networks, which was acquired by Nortel for $7.7 billion; digital-wireless carrier Nextel Communications, which boasts a hefty market value of $11.7 billion; and storage-giant Veritas Software, which tips the scales at a $25.9 billion market valuation.
Doll remembers the time well. Amid the flurry of telecommunications activity that came in the wake of the AT&T breakup, he helped launch Accel's telecom fund in 1988, "just two years after the introduction of local area networks.
"Just seeing how many devices, like personal computers and phones, that were connected to networks presented an explosive growth opportunity for connectivity," he recalls.
But the economy started to slip into recession, driven largely by the excesses of the savings-and-loan industry. Then, bombs started raining on Baghdad.
"I remember sitting in front of my TV screen as the Gulf War started, and next thing you knew companies started banning their employees from traveling and it caused PictureTel to just take off," Doll remembers.
PictureTel, a provider of video-conferencing services, was not actually setting the world on fire, but an external event such as the Gulf War gave it a kick-start.
PictureTel, which was an Accel investment, is being acquired by Polycom, an early maker of speakerphones, which was also an Accel investment. Two weeks ago, Polycom announced it was buying the video-conferencing firm for $362 million. While Accel exited PictureTel long ago, Doll says that it produced returns more than 10 times the original investment.
Table: Big Deals
Of course, Doll isn't banking on another global military conflict or other external event to save the day for early-stage investments made during this downturn. While there has been an over-funding in optical companies, Doll is bullish on the optical sector equivalent of contract-manufacturing companies. His firm is also invested in several communications security concerns. "One of the things that happens in economic downturns is that service providers, like companies that provide products that attack tactical problems, such as bottlenecks in the Internet, tend to do well," Doll says.
At least the pace of investing by venture capitalists has returned to a more sane level-as has the amount of funding, says Blaisdell, Doll's partner. Now you are likely to see one or two investments per quarter by a given fund, as opposed to four or more during the apex of the mania. "You were going much more on gut then. It was an unhealthy environment to build companies," Blaisdell says.
Valuations of start-ups are much lower than pre-crash levels, but they are likely to go lower, Blaisdell says. Also, under current conditions, start-ups aren't likely to see multiple rounds of funding before being expected to produce tangible results. Now most companies may receive something on the order of $15 million -- though there will always be exceptions -- to fully fund their business models, he says.
What's more, young private companies will be expected to become cash-flow positive about two or three quarters after getting funded, as opposed to six to eight quarters prior to the crash. The result: fewer companies will get funded, and they will not be able to spend each other into the ground.
Says Blaisdell: "We will no longer have circular firing squads of companies armed with $20 million shooting each other dead.">> |
