Mercury Center Business
   Published Sunday, Nov. 18, 2001, in the San Jose Mercury News 
   
new firms see window of opportunity to invest in early-stage companies

   BY [65]MATT MARSHALL
   Mercury News
   
   A new breed of fleet-footed venture firms is nurturing Silicon Valley
   tech start-ups, poaching the turf of established venture capital
   firms.
   
   Burned, and under pressure from their own investors to rescue their
   problem portfolio companies, older Bay Area VCs are throwing most of
   their resources at triage. These firms, including Benchmark, Accel
   Partners and Sequoia Capital, injected billions of dollars into
   failures like online grocer Webvan and DSL Internet connection company
   NorthPoint Communications. Now they're doing their best to save their
   remaining companies -- many of them promising, but many of them in
   hangover hell.
   
   That's why new Silicon Valley start-ups are starving for cash, and why
   a window has opened for new venture capitalists to invest in today's
   seedlings in hopes of gaining profits for the future. Some of the new
   VC entrants are foreign-based, from France or the United Kingdom;
   others are linked with local companies such as Agilent Technologies.
   
   Investments in the earliest stage companies -- receiving venture
   capital for the first time -- were $248 million in the third quarter,
   down from $390 million in the second quarter, and $1.5 billion in the
   third quarter of last year, according to VentureOne, a VC data
   research firm.
   
   Seed-stage and first-round funding has declined more sharply than
   late-stage investments. Early-stage investments made up 13.8 percent
   of the total VC spending in the third quarter, down from 18 percent of
   the total in same quarter last year.
   
   But take a look at the Silicon Valley companies that raked in the most
   VC during the quarter: The top five -- Rinat Neuroscience, Pine
   Photonics, Silverback Systems, Aarohi Communications and Iridigm
   Display -- all received money from at least one VC that was affiliated
   with either a foreign entity or a VC fund started within the last two
   years.
   
   True, there are signs that local VCs are starting to make some new
   investments -- but slowly. Take San Francisco's venture firm, Walden
   VC. Together with Rustic Canyon Ventures, Walden VC invested in
   Mountain View's Visto, a mobile software services company. However, it
   was Walden VC's first investment since June 2000, new or otherwise.
   
   ``We're definitely seeing a pulse,'' says Craig Johnson, director of
   Venture Law Group, a law firm that specializes in servicing start-ups.
   ``We couldn't detect a pulse a couple of months ago,'' he said.
   
   Battery Ventures, a VC firm with a large office in San Mateo, is
   spending so much time searching for outside money for existing
   portfolio companies that it hired a new partner, Stephen Terry, to
   raise money full time. That's a first in the VC world.
   
   Battery also announced it is in the market for making later-stage
   deals -- a change from its focus on only early-stage. Rich Moore, who
   handles marketing for Battery's portfolio companies, says the market
   downturn has created great opportunities in later-stage companies.
   
   They present less risk because they're already generating revenue. And
   the downturn has made them willing to fork over more ownership stakes
   in return for cash.
   
   Compare that with Societe Generale, the French banking group that has
   just formed a venture arm in San Francisco. Societe's two partners,
   Richard Hababous and Pascale Bouillon, arrived from France this summer
   to scour for early-stage deals. It will announce its first investment
   next week: $2 million into Mountain View's Ponte Communications.
   
   Ponte's chief executive officer, Brian Smith, said he talked with
   several VCs about raising money. One local VC firm decided to pass on
   Ponte, he said, but recommended his firm to Societe Generale -- which
   was swift to invest.
   
   ``Most VCs are distracted these days,'' Smith said. ``In the case of
   Societe Generale, they weren't as distracted.''
   
   Societe Generale expects to fund 10 to 20 new start-ups over the next
   three years -- a much stronger pace than most local VCs, considering
   they have only two partners. Sure, some local companies have hired
   more partners to make new investments. But hiring waters down their
   profits -- usually shared between partners -- so many firms have tried
   to avoid it.
   
   Take Gerard Cunningham, who worked as an Executive-in-Residence at
   Menlo Park's Mayfield Fund. He helped start companies within the firm,
   but it was not ready to hire another partner, he said. So Cunningham
   decided to join a Baltimore-based venture firm, ABS Ventures.
   
   ABS opened shop in the Bay Area two years ago, and invests money
   primarily on behalf of German-based Deutsche Bank. Cunningham's sole
   charter is to make new investments.
   
   If the Germans and the French are charging into the valley, the Brits
   aren't to be outdone. London-based 3i, a 55-year-old venture firm,
   entered the valley in fall 1999. By the time it got rolling, it missed
   the worst of the Internet bubble hype. ``It was pure luck,'' says
   Martin Gagen, who leads the group's valley effort.
   
   3i announced a consolidation in Europe last month, but it is still
   ramping up in Silicon Valley, Gagen says. In the third quarter, 3i
   pumped $3 million into Insevo, a Pleasanton software company.
   
   Gagen estimates that 3i's new investments over the past six months are
   35 percent higher than the same six months last year. He wants to pick
   up the pace even more in 2002.
   
   But there are new local players too. Palo Alto's Agilent Technologies
   didn't have a venture arm until early this year. But seeing valuations
   plunge, and wanting to get in on the cutting edge of technology, the
   testing equipment company appointed Maximilian Schroeck, a German, to
   start investing in new companies. So far, it has invested in 10 such
   companies, two of them in Silicon Valley.
   
   New Enterprise Associates, the big-name Menlo Park firm, is an
   exception. It made the most overall investments during the quarter,
   including into seven new companies -- one more than the previous
   quarter.
   
   ``It's five yards and a cloud of dust,'' boasts Richard Kramlich, an
   NEA partner, who says he believes it is the best time to invest in
   more than 20 years. ``It's an ideal time to get into the market,'' he
   said. ``The likelihood is that you're going to catch a wave.''
     _________________________________________________________________
   
   Contact Matt Marshall at mmarshall@sjmercury.com or (408) 920-5920.