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shaking the moneytree Q3/2000

what goes up . . .

Slowdowns in the public financial markets are having their effect in the private venture markets. For the first time since the Internet craze began, VC investments in the region are down from the previous quarter, and many experts expect the slowdown to continue. At this event co-sponsored by Netpreneur.org and PwC, held November 29, 2000, a panel of leading venture capitalists, analyzed data from PwC’s MoneyTree™ survey, with an eye toward what’s in store for  Greater Washington entrepreneurs in the future. There’s still money and opportunities out there, but everyone’s being a bit more selective.

Copyright 2000, Morino Institute. All rights reserved. Edited for length and clarity.

Commentary:   Jack Biddle, Novak Biddle Venture Partners
Richard Harris, SpaceVest

Suzanne King, New Enterprise Associates

Moderator:  Eric Ayres, PricewaterhouseCoopers

fran witzel: welcome

Hello.  I'm Fran Witzel, Vice President of Morino Institute's Netpreneur.org, the learning community for the New Economy.  On behalf of the Netpreneur team and our partner, PricewaterhouseCoopers (PwC), it's my pleasure to welcome you to Shaking the Money Tree where we’ll review the venture capital (VC) investment activity in the Greater Washington area for the third quarter of this year.

          You may have seen the recent Washington Post article on venture capital, which quoted PwC's MoneyTree™ survey.  There was a picture of a dripping faucet, and the headline was "The Cash Flow Slows But Investors Still Crave Region's High-Tech Startups."  VC investment has definitely slowed since the last quarter; and, yesterday, Nasdaq closed at a 52-week low of 2735.

          At our most recent Netpreneur.org event, Guy Kawasaki, CEO of Garage.com, talked about the “Top 10 Lies Of Entrepreneurs,” noting that no matter what anybody says, no one is glad that the bubble has burst.  He said, “Birds sing better, the sun is shinier, the sky is bluer¾everything is better with Nasdaq at 5,000.”

          On the other hand, Bill Gurley of Benchmark Capital wrote in the November 20, 2000 issue of his newsletter Above The Crowd, “The year 2000 will be remembered as the year that everyone caught a disease known as sanity.” He said that now is a great time for building great companies, and we are very fortunate to have a distinguished panel of investors with us this morning who can help build great companies. They'll share their views on what's been happening recently and what's ahead for the upcoming quarters.

          Introducing our panel and moderator is Jim Palumbo, engagement partner with PwC. Jim recently transferred here from Pittsburgh, where he served as partner with the firm's energy and mining industry group.  He was the lead engagement partner on Fortune 500 and Global 2000 companies, including two significant investor-owned utilities, Allegheny Energy and Consolidated Natural Gas, now Dominion.  Jim has more than 21 years of audit and business advisory experience, including experience with fast-growth technology companies. Some of Jim's key clients include Powertrust.com, The Westinghouse Electric Company, Telos, Ultraprise, Cyveillance and BioReliance. Please welcome to the podium, and to the area, Jim Palumbo.

          We are glad that you are here, Jim. I want to ask you, what are some of the observations that you've made during the past year?  What's been happening in business?

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jim palumbo: observations and introductions

Well, besides moving from the rust belt to the technology haven of Washington, DC, I guess I came here at the height of the euphoria when Nasdaq was right about 5,000 during the first quarter, going into the second quarter of 2000.  I guess I could characterize what I have seen in the six months since then is a lot of bankruptcies¾no, I’m just kidding.

          Seriously, though, what I see is a need for patience, and I see a lot of people on the investing side actually having some patience.  That's good for both the short term and the intermediate term.

          If you are going to invest¾if you are not invested, but you are going to invest¾I see a lot of selectivity out there.  The VCs I've met with are being very selective and they’re very concerned about where they are going to place their new money, or where they're going to reinvest in a company in which they've already invested.

          If you're an investee seeking money, I see the need, more than ever before—and maybe I'm stating the obvious here, but I think it needs to be stated again and again—I see the need for being focused and having the right commercial business plan that will excite people about investing in your company.  I see that as being essential to keeping this economy going and keeping the VC money flowing, which we are going to talk about here today.  If you are an investee out there, I think it's good to sit down and make sure you have a commercially-focused plan so that your ideas ultimately will pay off in growth. That is the main message I see coming out of our practice.

          Finally, I also see alternative exit strategies other than IPOs being seriously considered by VCs and investees alike.  Whether that’s mergers and acquisitions (M&A) activity with strategic people, joint ventures or other kind of business combinations, I’ve seen that happening in the last six months with a number of our clients in the region.

          I'm excited about coming to this marketplace.  I'm committing to this marketplace with a house¾which is a huge investment here¾so I'm counting on all of you being successful, and on PwC being able to help you in the process.

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          This MoneyTree survey is an excellent way to keep focus on where the money is flowing and what the good ideas are.  I laud the people who began this survey.  I think it's excellent for to us keep track of where the important trends are in the marketplace. With that, I'll take a few seconds to introduce our panel.

          Our first panel member is Jack Biddle of Novak Biddle Venture Partners.  Prior to co-founding Novak Biddle, he was the CEO of Annapolis-based Intercap Graphic Systems (IGS), a Fast 50 computer software company, from 1990 to 1995, when it was acquired.  Prior to that, he was principal of software-focused merchant bank Vanguard Atlantic where he put together numerous venture deals.  He has also served as CEO and COO of several Vanguard portfolio companies.  Jack currently serves on the board of AnswerLogic, DiamondBack Vision and Giga Information Group.  Please welcome Jack to our panel.

          The next panel member is Richard Harris, Vice President with SpaceVest.  He currently serves as a director on boards. including Computer I/O, MDLinx.com and Digital 5, and was formerly a director on the board of Cronos Integrated Microsystems, which was recently acquired by JDS Uniphase.  Richard also participates as an observer on the boards of VBrick Systems and AtYourBusiness.com.  Please welcome Richard to the panel.

          Our last panel member is Suzanne King with New Enterprise Associates (NEA). Suzanne focuses on information technology (IT) investments, and currently sits on the boards of Boxerjam, Cyveillance, EqualFooting.com, EyeCast, Guardent, Quantum Bridge Communications and Telegea.com.  Prior to joining NEA, Suzanne worked as a comptroller at XcelleNet, a developer of system management software¾which is good; she is one of us, an accountant.  Please welcome Suzanne.

          Last is our moderator, Erik Ayers, who I have the pleasure of seeing almost every day.  Erik has been with PwC since August of 1998, and is a manager in the firm's Global Technology Industry Group. He is a key member of our firm in the New Venture Development area with responsibilities for business development and entrepreneurial support services in this region.  He focuses on bringing audit, tax and eBusiness services and solutions to our clients.  Erik works as a liaison with all of our lines of services in an effort to position us to be service providers to all of you and help you succeed.  He likes small children and pets, the color blue and good sushi. Besides that, Erik is going to moderate this morning.

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eric ayres: a look at the numbers

Thank you, Jim and Fran, for your thoughtful comments, and thank you, panel, for being here today.  Most importantly, I want to thank the audience.  You are the reason why we are here.  Our intent is to provide as much value as we can to you on a quarterly basis, and we'll continue to do so.

          Here’s what we are going to talk about today.  Our panel will be discussing key points from the Q3/2000 MoneyTree Survey. First, we’ll present some key data, we'll explore it and discuss some issues that are emerging in the market, saving ample time for your Q&A.

          Before we get started, a couple of quick things about the MoneyTree survey.  We surveyed 950 venture funds for the most recent quarter.  MoneyTree is in its sixth year, and national and regional results can be found at http://www.pwcmoneytree.com. For those venture funds that have not participated before, you can do so online.

          We usually start these “Shaking The MoneyTree” presentations with a comment such as, “the most recent quarter marked another record-breaking quarter for venture capital in the Greater Washington region.”  Well, this quarter did not mark another record-breaking quarter.  In fact, we dropped out of the Billionaire Club which we made last quarter.  Nationally, just over $17 billion was invested in roughly 1,200 companies, an 11% decrease from Q2/2000.  Locally, we saw $877 million invested in Q3/2000, a drop of 30% from just over a billion dollars invested in Q2/2000.  Some might argue that absent the large telecom investments we have seen over the last few quarters, this quarter was not as bad as might have been predicted in Q2.  It was expected to be a really bad quarter.  But, again, absent telecom, not quite so bad.  Phrases like “down round” and “difficult Series B” and “impossible Series A” seem to be commonplace in the market, right now, however, and we will have the panel share their insights into that in just a moment.

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          Looking at the industries that raised money for the quarter, there are three key points I want to make:

-   The first is that health care services are beginning to emerge in this marketplace.  Q3/2000 marked the largest amount of money going into health care services since our survey started six years ago.

-   The second point is that telecom investments, again, declined.  In fact, Q3/2000 marked the lowest level of telecom investments since Q1/1999.

-   Lastly, software continues to dominate. The sector is very, very strong locally, with software companies raising approximately $400 million during Q3/2000, a 60% increase over last quarter and a 200% increase over Q3/1999.  Locally, software still dominates.

          Our survey also takes into consideration the fact that Internet investments cross all categories, so we have a subcategory or sub-industry group called “Internet-related.”  The most important point to take away here is that the “Tools & Applications” sector boomed during Q3/2000.  Of the Internet-related categories, Tools & Applications¾which includes ASPs, network traffic management, security software and such¾garnered the largest amount of investment.  B2B eCommerce continues to decline, as predicted, and B2C continues to face formidable challenges.  Here are the breakdowns for DC Metroplex investments by Internet sub-industry:

Internet-related Sector Q3/2000 (millions)  Q2/2000 
(millions) 

%
Change 

Access/ Infrastructure   $121.3 $196.0  -38.1
Services $156.2 $194.0 -19.5
Tools/Applications $259.3 $185.0  40.2
B2B eCommerce  $35.3 $118.0 -70.0
B2C eCommerce  $43.0 $54.0 -20.4
Content Sites $68.1  $38.0  79.2

          Because of the absence of telecom deals, as well as pressure on valuations, average deal size for this quarter dropped to just over $10 million from $15.3 million in the second quarter.  Nationally, deal size was virtually flat at about $10 million.

          We’ve gone through these data points very quickly, so I want to remind you that this information and a lot more can be found at the MoneyTree site.

(continued)

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