THE executive team from Kestrel Solutions Inc. recently did a whirlwind t=
our
of New York, Washington, D.C., Chicago and San Francisco investment group=
s,
aiming to raise $55.5 million for the Mountain View-based communications
company. At trip's end, investor offers totaled $80 million.``We had to d=
o a
hair cut and tell people that we didn't have room for everybody,'' said M=
el
Gafner, the company's chairman.
Kestrel is part of the tsunami of investments that is reshaping the Silic=
on
Valley economy, changing the way start-ups operate and taxing the
infrastructure of services needed to nourish them. Almost $2.7 billion wa=
s
invested in Silicon Valley companies by venture capitalists in April, May
and June -- a record high according to The Money Tree, the Mercury News/
PricewaterhouseCoopers LLP quarterly survey. As a result, Silicon Valley =
law
firms, accounting agencies and public relations companies that support th=
e
start-ups are losing their employees to the lure of the entrepreneur. The
battle to attract talent has become so heated that many executives from
established firms shoulder little risk -- sometimes not even a pay cut --
when they move to a small new company. And the competition to fund these
nascent businesses has become so fierce that venture capitalists are maki=
ng
investment decisions in hours that once would have taken weeks.
The challenge for many of the fledgling founders isn't whether they can
raise the money, but deciding whom they are going to accept as
investors.``We had to pick the ones who were going to help us the most go=
ing
forward,'' Gafner said. The downturn in the stock market earlier this mon=
th
could augur a shakeout among the new technology companies, but may just b=
e a
minor distraction, given the financial juggernaut behind the latest class=
of
start-ups.
Here's a snapshot of what's driving this engine, as captured by The Money
Tree.
1. Financing boom - Spiraling investments bring new problems
Nationwide, venture capital investment increased 77 percent to a record
high -- $7.615 billion in the second quarter of 1999 from $4.312 billion =
in
the first quarter.
About 35 percent of the second-quarter investments, or $2.654 billion, w=
ent
to companies in Silicon Valley, more than double the $1.055 billion inves=
ted
in companies in New England, the No. 2 region for venture investments. Mo=
re
than half the money nationally went to Internet-related companies, compar=
ed
with about one-third in the first quarter, and so far in 1999, 651
Internet-related firms have received investments, more than the 1998 tota=
l
of 641. When categorized by industry sectors, communications had the larg=
est
share -- 32.6 percent -- for the second time since the national survey be=
gan
in 1995, surpassing software and information with 27 percent.
Many analysts say this boom in venture financing cannot be sustained. It =
is
a one-two punch of problems: The costs of doing venture deals may be
spiraling out of control, and in turn, the recent turbulence in the stock
market suggests that the gold at the end of the rainbow -- the money
start-ups receive when they go public on the stock markets -- may be more
difficult to find. Law firms and consultancies that start-ups depend upon
are swamped with more work than they can handle. The Palo Alto office of
Gray Cary Ware & Freidenrich, for instance, was contacted by 19 start-ups
over the past few weeks, but accepted only five as clients. San
Francisco-based thedigs.com, a community-based Web site that allows users=
to
access information by hand-held computing devices, had to apply to public
relation firms, and was turned away by many that did not want its busines=
s.
``It's not us interviewing agencies, it's agencies interviewing us,'' sai=
d
Tim Wong, 27, the company's marketing director. Wong's career in some
respects helps explain the shortage: He worked at the Jonah Group, a publ=
ic
relations agency that supports high-tech start-ups, and could not resist =
the
temptation of trying to do what he saw so many of his peers doing. A simi=
lar
exodus can be seen at other professional service companies. The managemen=
t
consulting firm A.T. Kearney, for instance, has lost 38 employees out of
several hundred in its West Coast practice to start-ups since the start o=
f
the year. Another start-up, Carstation.com, was founded by a lawyer who l=
eft
Venture Law Group in Menlo Park and then recruited some of his new employ=
ees
from Wells Fargo Bank. ``The infrastructure in Silicon Valley is at the
breaking point,'' said Joshua Green, a director at Venture Law Group.
Recently at a breakfast meeting with Green, a veteran venture capitalist
confided that for the first time in his career he had taken less than a w=
eek
to decide to fund a company rather than considering it over the space of
several months. ``It's become so competitive he needed to make the decisi=
on
quickly,'' said Green. ``I have never seen so much stress on the system.'=
'
This change is a symptom of a larger shift in the way people are assessin=
g
the risk of joining a start-up. No longer does it necessarily involve a
tremendous pay cut to go from an established firm to a new Internet-relat=
ed
enterprise.
2. `Gap is closing'
Pay at start-ups growing faster than at older firms
Advanced-HR Inc., a Saratoga-based compensation consulting firm specializ=
ing
in start-ups, recently issued a report that found base pay increasing 60
percent more at start-ups than at mature technology companies.``The gap i=
s
closing rapidly,'' said Dee Dipietro, Advanced-HR's founder. The start-up=
s
are also offering cash bonuses to new executives, a practice that was
practically non-existent a few years ago, she said. In addition, employee=
s
are getting a larger share of the options, while the founders' take has
declined, she added. These new circumstances, along with the success stor=
ies
of companies like eBay Inc. and Yahoo Inc., have made many people more
willing to shoulder the risks of joining a start-up. And because of the
rapid rise of Internet-related companies, the jump is now available to ma=
ny
who once would not have had the technical skills to make the move. To be
sure, questions about the stock market may stem this flow of talent, if
people begin to doubt whether options in a start-up will provide lucrativ=
e
rewards. Venture capitalists may also reassess where they want to invest.=
In
the second quarter, for instance, 48 out of the 282 Bay Area companies th=
at
received venture financing are trying to provide business-to-business
services over the Internet, according to The Money Tree survey. Similarly=
,
another 52 in the Bay Area were either trying to do online sales to
consumers or develop a set of Web-based services and content for a specif=
ic
demographic of users.
3. Staking a claim
Building an identity is key to survival
The emphasis for these businesses is not on developing new technology, bu=
t
on building a brand name and staking out a presence in a new market. They
need employees with backgrounds in marketing and media as much as in
engineering. With the recent turbulence in the stock market, particularly
among e-commerce companies, some analysts question whether this particula=
r
niche has become oversaturated with money and players. Several such
companies have ranked among the worst post-IPO performers of the last yea=
r.
For instance, Topjobs.net PLC, an online recruitment advertising business=
,
has seen its shares drop 61 percent since its IPO in April. Fashionmall.c=
om
Inc., an Internet clothing and footwear retailer, fell 53 percent since M=
ay.
And Quokka Sports Inc., which provides Web-based sports programming, has
declined 32 percent over the past few weeks. ``People are trying to find
category leaders in every segment, and everyone's doing a land grab in ho=
me
supply, automobiles, foods, drugs, music, pet food and so on,'' said Pete=
r
T. Morris, general partner in the Menlo Park office of New Enterprise
Associates. ``When you start to see five online pet food companies, you h=
ave
to start asking, how big is this market?'' Make no mistake, Morris remain=
s
upbeat. With the widespread adoption of the Internet, he is convinced tha=
t
demand will explode for new communications technologies that will allow d=
ata
to be moved more rapidly. ``This is a breakout time for Internet
infrastructure companies,'' said Morris, whose firm financed more
companies -- 31 in 1999 -- than any other venture firm that participated =
in
the survey.
Of all the companies that went public in the last year, the three whose
stock has increased the most since their IPOs are all communication
equipment companies in Silicon Valley: Redback Networks Inc., Brocade
Communications Systems and Juniper Networks Inc. And Morris added that at
least a few of the e-commerce companies are going to be huge, so investin=
g
in some is worth the risk. Other venture capitalists apparently agree, as=
in
the last quarter, many of the biggest deals in the Bay Area were in the
e-commerce category: $20 million for the online sporting goods retailer,
Fogdog Sports; $59.3 million to the online pharmacy, Planet Rx; and $30
million to the Internet wine store, Virtual Vineyards.
The strategy behind such Internet plays can be seen in the biggest
investment in the Bay Area: San Francisco-based ThirdAge Media Inc., a
3-year-old company that has established an online community for aging bab=
y
boomers. It received $89 million in June, including $54 million from CBS
Corp. for a 30 percent share, placing the company's value at $180 million.
Not a bad figure for a business that has yet to turn a profit and whose v=
ice
president of finance declined to say when they expected to earn one. Comp=
any
officials said it had exceeded its fundraising target, but decided agains=
t
limiting the amount.
``We saw an opportunity to enforce our lead as the first mover in the
space,'' said Shelly Porges, executive vice president for marketing, noti=
ng
that the increase in total money was accompanied by an increase in the pr=
ice
per share. While ThirdAge expects other companies to compete for the
eyeballs and pocketbooks of its target audience -- the 45- to
65-year-olds -- this will allow the company to build its brand without
having to feel time pressure to take it public, she added.
4. A helping hand
Finding funding easier than finding partner
That comfort level involves more than money. Like many of the other
companies that received funding in the second quarter, the name of the ga=
me
isn't just to raise capital, but to build alliances and establish
partnerships. ThirdAge, for instance, has increased its potential reach b=
y
aligning itself with CBS and another investor, the newspaper and online
publishing company Hollinger International Inc. Tony Meneghetti, a managi=
ng
director in the San Francisco office of Deutsche Banc Alex. Brown, which
organized Kestrel's $55.5 million private placement, said that one of the
big successes of that effort was getting an investment from the Washingto=
n
D.C.-based Carlyle Group, whose partners sit on the boards of many of the
top telecommunications companies. ``Raising the money is not difficult
today,'' Meneghetti said. ``It's picking the right partners that's the
bigger challenge.''
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335