MONEY MAKERS
Venture Investors Still Placing Bets in Beaten-Down Technology Sector
by Rajiv Vyas
For a few years it looked like technology’s billionaires would take over the Business Journal’s list of Orange County’s wealthiest.
Well, the tech meltdown put an end to that. Our list, while still sprinkled with tech representation, is a healthy mix of real estate moguls, heiresses and old-fashioned manufacturing leaders.
But technology’s not dead. Startups with driven founders populate the county. They might be having a tougher time getting money. And the terms of the deal have certainly changed. But the venture industry insiders contacted by reporter Rajiv Vyas say there are some good companies in growing technology sectors that deserve investment. If the price is right, there is money to be made.
Tony Pritzker
Chief executive, Pritzker Group LLC, Seal Beach
In the movie “Wall Street,” veteran actor Hal Holbrook tells young upstart Charlie Sheen, “You’re on a hot streak, Bud, enjoy it while it lasts because they never do.”
The technology companies of the late 1990s were definitely on a hot streak. I remember investors sarcastically saying, “I hope we don’t make profit because we won’t be hot anymore.”
Pure technology plays like Netscape and technology exploiters like Amazon.com attracted investors because of their new technology and market share. Other companies followed the models.
The old-fashioned investors like Warren Buffet sounded like Hal Holbrook to Charlie Sheen,”Buyer beware.”
Now Mr. Buffet looks correct in his foresight.
The old rules do apply. Whether the company is a technology provider, technology user, or consumer service organization, blocking and tackling have come back as basic necessities. What is the expense burn? What is the net revenue? What is the debt structure? What is the investment return? How good is management? How good is the company’s technology? What are the future capital needs?
These are basic questions we ask before we get to market share or upside potential. We apply these questions to any company, whether it is Seal Beach-based Baker Tanks Inc., a waste pumping and storage company, or Tavve Software, a network service company.
Greg Yurkovich
Associate, Forrest Binkley & Brown, Newport Beach
I think technology-focused investors are faced with some difficult investment decisions at the moment.
Markets clearly cannot maintain so many technology companies, regardless of their technical merits. While you try to mitigate risk by investing in exceptional technologies with proven managers, it’s ultimately the market that will determine the value of a company’s value proposition.
At this time, there is no clear place in technology to put your money.
Targeting spaces that directly supply the major telecommunications companies is probably not the wisest place to put your money at the moment,large-scale system plays, for example.
Semiconductor startups may also have some difficulties given their long development cycles and typically high capital requirements.
We’re considering novel technologies in the components, software and wireless sectors at the moment. We think that many venture capital investors have learned a tough lesson by simply following other groups that invested in so-called hot sectors.
Dan Bassett
Venture partner, InnoCal Venture Capital, Costa Mesa
Our most active area is enterprise software, but we’re also interested in wireless technologies, communications, storage, security and Web services.
Two examples of recent InnoCal investments are Santa Monica-based Accruent Inc. and Irvine-based TCI Solutions Inc.
Accruent is providing contract management software to Fortune 1000 companies.
The software solves a very real problem within their target market,how to effectively manage contractual obligations and agreements.
Companies can track contract terms and conditions using Accruent’s software and can automatically issue checks to vendors, which helps avoid costly mistakes, penalties and hidden overpayments.
TCI Solutions helps automate much of the retail industry. As retailing,particularly the grocery segment,continues to consolidate and move horizontally into other retailing categories, enterprise automation and optimization have become more important than ever. TCI’s software products enable retailers to better manage items and vendors, inventory, pricing, budgeting and personnel.
I would categorize both of these investments as software companies that take advantage of the Internet.
In 1999, the same companies might have been tempted to call themselves Internet companies.
Both of these software companies already had completed products and solid customer activity when we got involved.
We’re seeing more and more investment opportunities with completed products and solid customers.
Randy Lunn
General partner, Palomar Ventures Management LLC, Irvine office
At Palomar Ventures we never drank too deeply from the dotcom Kool-Aid and rejected the Shallow Hal notion that e-commerce was a Web site and a shopping basket.
We stayed focused on our traditional formula and continued the company building process throughout the dotcom potlatch. But where do we go from here?
The information technology economy is slipping sideways and there are no apparent killer applications driving a recovery. Corporate customers are not spending heavily on infrastructure and current projects need to show a fast payback to continue funding. The economy is still digesting all of the excesses of the late 1990s, the terrorist attacks and the loss of confidence on Wall Street with investment banking, management and accounting scandals. Long-term perspectives have been traded for near-term management control and cash preservation. These unsettled conditions are true for the moment and perhaps the next year.
Palomar invests in the information technology sector with emphasis on broadband communications, enterprise software and enabling information technology solutions. Our portfolio stretches from silicon chips to software to services. We will continue these investment themes.
Mark Monaghan
Chairman of The Tech Coast Venture Network
The message from investor panelists at Tech Coast Venture Network forums continues to be one of cautious optimism. Companies that are generating revenue and profitability,or close to profitability,are given preference.
Investors are rarely investing alone. Most funding rounds include three or four investor groups to share the risk.
Valuations have returned to “pre bubble” levels, and terms are strictly negotiated. Money that was once given as a lump sum is now distributed only as milestones are achieved. Management and path-to-profitability continue to be the top two criteria in evaluating investment opportunities.
The hot sectors for high technology investment are primarily in security and storage. The security sector is attractive mainly as a result of the Sept. 11 attacks and the subsequent war on terrorism.
The storage sector is also an attractive investment, mainly because of the large amount of data being gathered, exchanged and analyzed over the Internet.
Panelists at a recent venture network forum, including Irvine-based Epicor Software Corp. and Newport Beach-based Conexant Systems Inc., said their motivation is primarily strategic as opposed to financial.
They are looking for technologies and companies that will enhance their product lines or expand their markets.
In a recent discussion with a member of the Tech Coast Angels,and a member of our board,I asked what he considered a good return on his investment.
His reply: “At this point, I’m happy to get back 80% of my original investment.”
James Scheinkman
Partner, business & finance group, Snell & Wilmer, Irvine
For many companies that are able to raise venture capital, the economics of the transactions have changed significantly from two years ago. The “pre-money” valuations that venture capital firms are placing on companies for the purposes of establishing their investment are generally much lower, meaning that venture investors are spending less money for an equal or greater ownership percentage in portfolio companies.
Further, the amount of money raised per round of financing is smaller and, rather than wanting to be the sole investor in a round, many venture investors now are requiring that several venture or institutional firms participate. Moreover, the amount of time that it takes companies to close a round of financing has lengthened.
Technology companies seeking financing need to take prudent steps to adjust to these realities. Companies will be required to be judicious in their use of cash, consider alternative sources of financing through customers, vendors and strategic alliances with other companies and spend more time and start earlier in looking for new venture investors to lead and participate in future rounds of financing.
In addition to lower valuations, many venture firms are insisting upon much more favorable investment terms. Moreover, many venture investors are requiring tighter control over company operations and requiring company founders and executives to remain with the company for longer periods of time before the founders’ and executives’ ownership interests vest.
In this environment, it pays for companies to think strategically by picking their battles over which issues to negotiate and paying attention to the fine print.
Thomas Gephart
Founder and chairman, Ventana Capital Management LLC, Irvine
Ventana invests in the sectors that we believe have the greatest potential for medium- and long-term wealth creation.
In technology, that includes communications infrastructure and semiconductors, where innovation and entrepreneurship are alive and well.
There are many problems that need to be solved in these areas, and solving them will spark demand for replacement of existing technologies and deployment of new ones. Many people are looking to fund the “killer app” that will drive the next technology boom. But we prefer to fund the technologies that enable such applications.
Quantum and DNA computing are trends to watch, but it is too early to tell when these will become a reality or to which applications they will be well-suited.
Metro and last-mile networks must be significantly improved to deliver on the promise of rich media applications such as video on demand, voice over Internet protocol, video conferencing at TV quality, interactive gaming and so on.
Optical networks and components are at a relatively early stage of development, requiring an enormous amount of improvement to simplify and drive down the cost of design, manufacturing and packaging.
Our view would be incomplete without mentioning the overlay effect of miniaturization. We don’t see ourselves investing in a “nanotechnology company,” but rather in a semiconductor or communications company that uses these technologies. Increasingly, the lines between once-distinct sectors are becoming blurred, often creating entirely new sectors,and, hence, new wealth creation opportunities.
Shivbir Grewal, Partner,
Gene Mueller, associate,
Stradling Yocca Carlson & Rauth, Newport Beach
Venture capitalists appear to be focused on choosing technology and management teams with clear paths to profitability. And they are investing less.
So many companies are tapping one of the few active investor markets available,secured non-bank lenders. These investors comprise a very diverse group, from more traditional secured equipment and credit facility lenders to true equity players seeking a long-term investment with significant upside potential.
In return for taking more risk than a bank, secured non-bank lenders look for equity-type returns. But unlike unsecured lenders they may not have the stomach to continue investing in emerging technology companies without the downside protection of a security interest.
We are seeing a significant increase in the volume and size of these transactions, for both public and private companies.
Rather than depend on the market’s appetite six to nine months in the future for an early- to mid-stage equity financing, company management may prefer to take a loan on reasonable terms while the balance sheet is still healthy. Given ongoing uncertainty in the equity markets, this is a valid strategy for many companies. But if the lenders demand a blanket security interest in all of the company’s assets,including critical intellectual property,a secured loan transaction may look more like a “bet the company” scenario.
Bruce Hallett
Managing partner, Miramar Venture Partners, Corona del Mar
While 2002 has seen continued consolidation and retrenchment in the information technology sector, it appears that the underlying digital transformation of our society is moving forward unabated.
Rather than questioning the fundamental trends, we need to reset our expectations regarding the magnitude and timing of these changes.
In the wireless arena, low-power highly-integrated chipsets are under development by the larger companies as this becomes a mature industry. Efforts are under way to deploy multiband antennae and chipset technologies, and to achieve higher levels of integration in handsets and personal digital assistant devices. Future opportunities for venture investing exist in applications and services as the next-generation infrastructures are deployed.
The software industry has been strongly affected by the post-dotcom economic downturn. While Miramar’s objective is to concentrate on the enterprise market, it is important to mention some of the transitions occurring at the systems level. Based on Microsoft’s .NET strategy, we expect to see more network management, distributed applications on the server level and applications spanning all user devices, including personal computers, digital assistant devices and cell phones.
Another trend, and not unrelated to Microsoft’s dominance, is the growing adoption of Linux. Today, Linux appears in embedded systems, servers and mainframes.
For enterprise application software, the Internet has produced significant and permanent changes. The enterprise is now connected and all the traditional application providers like SAP, Peoplesoft, Siebel and BMC Software have integrated Web-based applications and services into their software. Although these large applications providers are not easily displaced at their large customers, this segment continues to be a good opportunity for new innovative companies and potential mergers and acquisition exits for investors.
A growing part of the connected enterprise is the mobile application sector. Mobile employees in sales, manufacturing and services need to get connected to enterprise applications. Implementation of secure systems, personal firewalls and authentication is a key milestone. These categories have become the current focus of a number of investors.
