NEA: Old Money, New Technology
By Brendan Barrett,
Washington Techway Staff Writer
The Washington Post
Friday, January 18, 2002
It would be easy to walk past the two aging, adjoining brownstones on the 1100 block of St. Paul Street in Baltimore and never know that the place has any connection with Silicon Valley, billions of dollars and some of the nation's most prominent technology companies.
A small brass plaque next to the front door of 1119 simply says "New Enterprise Associates." Most passers-by probably don't even know it is a venture capital firm, let alone the second largest in the nation.
The old, established look of NEA's Baltimore office - both inside and out - suggests this venture firm is quite different from many others that sprang up in the region during the past few years. And in many respects, it is.
NEA was no exception to the venture capital fallout in 2001. Twenty-one of its portfolio companies, or 10 percent of its active investments, didn't survive the year. Though it largely avoided dot-coms, the firm invested heavily in telecom equipment companies, a sector that has taken a heavy beating.
But, to the envy of many struggling venture firms, NEA not only continues to make investments in a down market, but it is positioning itself to pounce on new opportunities when the economy improves. The 24-year-old venture powerhouse has added four partners and an associate to its East Coast offices during the past several months and now has 23 active partners in Baltimore, Reston and Silicon Valley. They will help invest NEA 10, the largest startup fund in U.S. history, which was closed in September 2000, at $2.3 billion.
"Now is the time to build infrastructure before the next set of opportunities emerge," says Managing General Partner Peter Barris. "We're building it for what we envision is a very bright future."
Where will all that money be invested? In the late 1990s, about 90 percent of NEA's money went to information technology companies.
Today, the firm is increasing investments in the life-sciences sector, and roughly one-third of NEA 10 is expected to go to health care companies. The remaining two-thirds will go to IT companies, but Barris says NEA will focus less on the communications sector and more on enterprise and security software companies.
"We think the enterprise software sector will emerge sooner than the communications sector," he says. One exception: NEA remains bullish on wireless.
Today, NEA has 176 active portfolio companies - 126 information technology startups and 50 medical/life sciences investments. Though the firm doesn't have specific investment quotas, Barris expects the investment pace in 2002 will be pretty similar to 2001, when, excluding follow-on investments, NEA invested $260 million in 27 new portfolio companies.
Make no mistake: NEA is a national venture firm that happens to be located in Baltimore; it is not a Baltimore or even a mid-Atlantic-centric firm. With a bi-coastal presence since its founding - its West Coast office is on the renowned Sand Hill Road in Silicon Valley - NEA has invested in hundreds of startups nationwide.
Still, NEA partners stress their commitment to the mid-Atlantic. Co-founder Chuck Newhall notes that while 20 percent of the firm's investment dollars go to mid-Atlantic companies, less than 1 percent of the money the firm raises comes from the region.
"We are probably the biggest capital importer of anyone in the history of the mid-Atlantic, and nobody understands that," Newhall complains. "The Sun papers, which is basically a communist propaganda sheet … used to say, 'NEA gets all its money from Maryland and sticks it in California.'"
It's no surprise NEA has been in hiring frenzy during the past several months - the firm simply needs more partners to invest that $2.3 billion fund.
Biotech entrepreneur James Barrett, the former CEO of three NEA-funded companies, joined in September as a full-time partner and is expected to boost the firm's search for promising drug delivery and discovery investments. "A number of relatively later-stage deals are being priced attractively for us, and some of the clinical risk is already out of the project," he says.
Last month, Barrett, who most recently was CEO of Sensors for Medicine and Science in Germantown, landed his first deal: a $20 million investment in Pharmion of Boulder, Colo.
John Sidgmore, vice chairman of WorldCom, also joined NEA in late 2001 in a part-time capacity. Sidgmore's relationship with the firm goes back about 10 years, when Barris brought him in as CEO of UUNet, a NEA-funded company that later made an initial public offering and was acquired by WorldCom. Within three years, NEA's $3.9 million investment in UUNet was worth a whopping $260 million.
NEA already has funded one startup Sidgmore brought in: Boingo Wireless, a Los Angeles company launched by the founder of Earthlink. Sidgmore is on Earthlink's board.
Joining NEA this month were George Stamas, who retired as vice chairman of the board at Deutsche Banc Alex. Brown on Jan. 1, and Harry Weller, formerly of FBR Technology Venture Partners.
Like Sidgmore, Stamas will be working part time for NEA, bringing in deals from his wide network of contacts. Weller will be working full time, specializing in information technology deals. The firm also hired a consultant this summer, Chris Shen, a medical doctor who has already received a number of patents and will return to the Baltimore office as a principal after he finishes his MBA at Stanford.
But it doesn't necessarily take a track record such as Sidgmore's or Barrett's to become a partner at NEA. Newhall says an associate can become a general partner after bringing the firm $100 million in profits.
The firm's impressive list of partners already include one Nobel Laureate and a Fortune magazine columnist, and Stanford MBA graduates narrowly outnumber Harvard MBAs, 4-3.
Their top-notch reputation in the venture community is evident, partly because when NEA invests, others join the party.
"It is absolutely an advantage for NEA to lead the first round," says Wenli Yu, CEO of Seneca Networks, a Rockville optical networking equipment company in NEA's portfolio. "People know they do their homework, so a lot of smaller VCs become interested in jumping in on the investment." Yu says 10 local venture capitalists expressed interest in investing in Seneca's first round in early 2000 after they learned NEA was leading the deal.
Similarly, Gordon Saussy, CEO of Megisto Systems, a Germantown wireless equipment provider, says that when Norwest Venture Partners, a Silicon Valley venture capital firm, decided to fund his company in 2001, it was with strings attached. "They very much wanted to have a blue-chip East Coast firm [participate in the deal]," he says. "They said, 'We want NEA,' and it was very clear that part of our mission was to get NEA on board."
Even entrepreneurs whose companies didn't make it have decent things to say about NEA. "My feelings toward NEA are not negative," says Shaun Amini, former CEO of Eyecast, an NEA-funded Herndon company that shut down in May 2001. He says the venture capitalists who invested in Eyecast lost all their money. "It was a very challenging time, and I was pleasantly surprised by their support," he says.
In fact, it's hard to find anyone who will say anything critical about the firm, though two of NEA's former partners declined to be interviewed, including Art Marks, who was voted out last summer after longstanding differences with the partnership.
NEA traces its roots to the summer of 1977, when Frank Bonsal, an investment banker at Alex. Brown, began talking with Newhall, a young analyst from T. Rowe Price, about starting a venture fund. "I knew a lot about the venture business because my father had been in it from around 1945 on," says Newhall.
Bonsal says T. Rowe Price was willing to back them, but required that they bring on an additional partner with venture capital experience. They soon added Dick Kramlich as the third co-founder, a venture investor in San Francisco who had worked with Arthur Rock for about 10 years. Rock was one of the founding fathers of Silicon Valley venture capital. He funded Fairchild Semiconductor, one of the first companies to make transistors for computers, and then funded a company named Intel. Among Rock's other major investments was Apple Computer.
After going without pay for a year, NEA's founders closed their first fund at $16.4 million in 1978. The fund's two lead investors were the Deere family - of John Deere tractors - and T. Rowe Price, which chipped in $1 million.
Newhall says investors who funded NEA 1 and the organizations those people created account for about 70 percent of the money in NEA 10. Some of the money in NEA 1 came from people in the insurance industry, who subsequently left to form the "fund of funds" business, which are funds that invest in multiple venture firms.
One of those people, says Newhall, was Ray Held, who invested for the account of AT&T and formed Abbott Capital. From AT&T and Abbott, NEA ultimately brought on these investors for its funds: all of the Baby Bells, Lucent Technologies, Calpers - the California Public Employees Retirement System and an Abbott client - and JP Morgan, which managed AT&T's money. "Ray Held and his lineal descendants accounted for $700 million to $800 million in NEA 10," says Newhall.
But the environment for investing in startups in the late 1970s and 1980s was quite different than today. "People in Baltimore didn't really know what venture capital was all about," notes Bonsal.
Newhall says there were about three venture firms in the region at that time - Greater Washington Investors, which was really a real estate firm; Bro Ventures, which hadn't made an investment in more than 25 years; and Data Science Ventures, in Princeton, N.J.
Frank Adams, a fellow Baltimore venture capitalist who founded Grotech Capital in 1984, says NEA was really the "only game in town" until Grotech formed, and NEA even played a role in Grotech's creation. According to Adams, Frank Bonsal not only introduced him to Ed Sager, who later became Grotech's other co-founder, but also to Newhall, who "very much became a mentor to me."
NEA was clearly the experienced venture firm on the block: When Grotech raised its first $12 million fund in 1984, NEA was closing its third fund at $126 million. Though Adams and Newhall co-founded the Mid-Atlantic Venture Association in 1986, Adams gives Newhall all the credit. "It was very much Chuck's idea," he says.
But the 1980s weren't exactly like the 1990s in terms of technology deals: NEA's first co-investment with Grotech, in 1984, was in a women's clothing company, Joshua Slocum. NEA even had a partner at the time, Ray Bank, who specialized in retail deals. Bank, who has an office at Grotech, declined to be interviewed.
Newhall considers NEA 3, a $126 million fund closed in 1984, the firm's least successful, mainly because the initial public offering and merger-and-acquisition markets had slowed down considerably in the mid-to-late '80s, leaving portfolio companies without an exit strategy for a long period. He says NEA 3 had about a 6 percent internal rate of return, a measurement that considers investment returns over a period of time. Historically, venture capital has an IRR of 20 percent to 25 percent, about double the return of large cap stocks.
The Internet boom of the late 1990s was a prosperous time for venture capitalists, and NEA was no exception. Topping its list of blockbusters was an investment in Juniper Networks, a top 25 IPO in 1999, which skyrocketed from $34 a share to $340 a share in its first six months on the market. The firm's $3 million investment in Juniper in 1996 produced a return of more than 500 times the investment three years later, by far NEA's most financially successful deal.
Another short-turnaround, big hit was a company called Xros (pronounced Cai-ros). NEA was part of a $20 million venture round in late 1999, and seven months later, Nortel bought Xros for $3.2 billion, netting NEA about $700 million. Newhall says that deal made one principal in the firm, Rob Coneybeer, a partner much faster than the usual 10 years. "You have to acknowledge the person who did that," he says.
Newhall says that, historically, 10 percent of NEA's investments return "an enormous amount of money," about 10 times or more of the amount invested; 30 percent earn 5 times; another 30 percent the firm "will work its tail off to recover most of what we put in" and 30 percent will lose all or most of the investment.
"At the height of the [tech] bubble, 10x [10 times the investment] seemed to be at the floor," says Barris. "We were more looking like 40x to 50x our money would be a very good return."
There were some regrets along the way.
NEA passed on an opportunity to invest in Netscape. It also decided not to invest in Ciena, the optical networking company in Linthicum, the firm's own back yard. "We were right there, and one partner we had, who was a very negative person, talked us out of it," says Newhall. "Fortunately, the son of a bitch is gone; he's no longer with us."
Though NEA had been through investment cycles before, its experience did not appear to make it less wary about the impending burst of the Internet bubble. In 2000, for example, when valuations of privately held companies were peaking, NEA poured $1.04 billion into 133 companies, an aggregate total that includes both new and follow-on investments.
The firm ranked No. 2 behind JP Morgan Partners for the amount of venture capital invested in 2000. "We were seeing investment opportunities at a pace we had never seen before," says Barris, "what we thought were quality opportunities."
Of course, not all the investments worked out so well. NEA prides itself on having avoided most of the dot-coms that burned venture capitalists in the past year and a half, but it didn't avoid all of them.
Barris says one of NEA's worst investments in the late '90s was a company called Egreetings - greeting cards over the Internet. "The business model made no sense. It had all of the buzzwords, such as 'aggregating eyeballs,' but no one could figure out exactly how to monetize it," he says. "We didn't believe in the business model, but we believed [the management team] would figure it out." Egreetings was later acquired, but NEA lost about 75 percent of its $6 million investment. "They were truly a dot-com," he says.
But heavy investments in telecom equipment companies during the Internet boom began to take a toll during the downturn.
In mid-2001, with no exit strategy in site for many of its capital-intensive telecom equipment portfolio companies, NEA raised a $150 million annex fund for NEA 8, in order to continue to support the 53 still-active companies in NEA 8. Annex funds, pejoratively known as "bail out" funds, are often viewed as a bad sign because it demonstrates that the portfolio companies are unable to issue an initial public offering, get acquired or get financing from other venture capitalists.
"We could have got by without raising an addendum fund, but we wouldn't have supported the companies to the degree we wanted," says Barris, noting that the additional investment by the limited partners was voluntary. Barris says NEA does not at this point expect to have to raise an annex fund for NEA 9, its 1999 fund, though that fund "does have some of the same characteristics of NEA 8."
NEA continues to spend a lot of time on its portfolio companies, most of which are in a holding pattern until the IPO or mergers-and-acquisition markets return to healthy levels. "When companies come up for a financing is the big determinant - do they get financed or go out of business?" says Barris. "If they are financed, we try to get them to cash flow break-even."
Of NEA's regional investments, Equalfooting (later called Equidity), Eyecast, Opion and The .Com Group didn't get additional financing in 2001, and all went out of business. Newhall's view of the Internet bubble is pretty straightforward. "I call it a drunk," he says, "and now we have a hangover."
Newhall realizes the coming years will bring a big transition, but he is preparing for it. "Frank [Bonsal] is partially retired, Dick [Kramlich] is 68 years old, and I'm 57," he says. "We're going to have some partners who are going to be stepping down, so you have to bring on the next generation.
"The founders haven't gone away, we're just working with the next generation of management," he says. And Newhall, well aware that partnerships, unlike corporations, are set up with a finite life span, is taking steps to ensure it continues for the next generation of partners. "We've always given away the bulk of the carried interest to the new people coming on board," he says. "Our firm has acted much differently than the bulk of the people in the industry. Where founders might keep 80 percent of the partnership's profits, we keep 15 or 20 percent."
Though venture firms are set up to produce a return on investment for the limited partners, the ones who actually provide the money for each fund, Newhall tends to look at the types of companies NEA has helped create as a measure of success. "You can't look at a company that necessarily produces the best return," he says about identifying the best companies NEA has funded. "The issue is what becomes of the company over the long term," he says, ticking off sectors in the high-tech industry that he says NEA has helped create - Ethernet, local area networks, high-speed data communications, human gene therapy and outpatient health care.
"All I can say is that history will show what rank we are," he adds. "And the thing that shows our rank are the companies we produce. The rest is bullshit."
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