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May 31, 2000

Shaking The Money Tree III, Q1/2000:

The Wrath Of Nasdaq

(Reston, VA -- June 4, 2000) According to PriceWaterhouseCoopersí (PwC) latest MoneyTreeô survey, in the first quarter of 2000, venture capital investments once again broke all records, both in Greater Washington and around the country. But by quarterís end came a plunging stock market, with the Nasdaq and its Internet stocks hit especially hard.

"Did the bubble burst, and do these market changes signal that the venture capital well is now beginning to run dry for our region?" asks Erik Ayres, Business Development Manager for PwCís DC Metro TICE Practice.

Ayres was moderator of Shaking The MoneyTree 3, a quarterly event co-hosted by PwC and the Morino Instituteís, in which a panel of VCs provide commentary and analysis of the MoneyTree numbers, with special focus on what they mean for Greater Washington netpreneurs. At this quarterís event, panelists Patty Abramson of Women's Growth Capital Fund, Patrick Kerins of Grotech Capital Group and Steve Walker of Walker Investment Funds discussed such topics as the regionís place, the value of venture fairs, and the growing role of corporate venture funds. But Ayresí question kept surfacing: What effect will the marketís gyrations have on netpreneurs seeking venture capital?

According to Walker, "Yes, something happened in March and April that brought the market back to earth, but this, in itself, isn't the end of the world. If you have been in this game for any length of time, you know that this happens every so often. There was a reset back in the fall of 1998 that hurt a bunch of folks. There was a reset in July of 1996 that I remember incredibly well because we were preparing to do an IPO in July of 1996."

Before getting into the venture game, Walker founded Trusted Information Systems (TIS), an early success in the Internet security market. He told a tale of personal confrontation with a gyrating stock market. "We had started in May, and we were on a crash program to make this happen. On July 5th, the market went gazunk. We had meetings and everybody said, ĎThat's okay, it will be better by Tuesday.í On Monday it went gazunk. On Tuesday it went gazunk. There were four or five gazunks."

Walkerís company postponed their IPO for two months in 1996, using the time to improve their fundamentals. Trusted went public in September, and was eventually acquired by Network Associates in a deal valued at $350 million. Many companies today are waiting too, pulling or postponing their planned IPOs in response to the marketís gyrations, including three in greater Washington. Indeed, the consensus was that the greatest effects will be felt by the later stage companies which are preparing to go public, rather than on startups.

"The IPO market is definitely trickling," noted Kris Muller, a partner with PwC's Global Technology Industry Group in the DC Metroplex area, "but we are seeing IPOs in the holding pattern, right now. People in this region haven't surrendered to the market. They are still not optimistic, but holding their own that the market will, in fact, turn around. The substance of the IPOs out there and waiting are the ones you would expectĺ the infrastructure, software and technology companies that are helping to build the Internet, and the Internet isn't going away."

Abramson likens the climate to that of the real estate boom in the 1980s. With 20/20 hindsight, people asked later, "What were the banks doing lending all this money to these companies without any collateral?" She predicts similar effects for VCs today, "One thing that's happening is that this is forcing us to do the job we should have been doing all along, because part of our role, other than making money for our investors, was to get these companies out there, healthy and ready when they went public or merged. In some cases, we were greedily pushing them along, and they weren't really ready to go out."

While later stage, IPO-bound companies may see more dramatic effects as a result of market conditions, donít expect it to effect the flow of startup money. According to Grotechís Kerins, "The best measure of demand for venture capital deals is the total amount of venture capital funds under management, and that number has grown in this quarter. There is now more money on the sidelines committed by institutional investors to venture capital firms looking for venture dealsĺ more now than there was a quarter ago."

The panelists do expect two things to happen relative to startups, in fact they have already begun to happenĺ lower valuations and deals where there is a greater sense of financial substance to the company. According to Kerins, "My sense is that the deal flow and the willingness of firms to close on deals in this region has not changed much. I think we are in a reasonably typical pattern where, when valuations change, there is a little bit of circling going on. An entrepreneur may have been fairly advised three months ago that his or her company was worth X, now is hearing from venture capitalists that it's .6X or .7X."

Ironically, this trend may play right into the Greater Washington regionís strengths. For one thing, the regionís deal flow is heavily weighted toward startupsĺ 58% according to the MoneyTree survey. As Abramson pointed out, "As the valuations have gotten higher, a lot of the smaller funds are finding that they need to invest earlier and earlier to get a piece of the pie."

Perhaps more importantly, the areas in which this region is particularly strong, such as B2B applications and Internet infrastructure, do not require huge sums of investment capital the way the deep technology and hardware companies of Silicon Valley or Boston do. Says Kerins, "You see companies that could create potentially multi-billion dollar companies on $3-$4 million with a dozen people. Thatís become a very attractive place for venture capitalists to go." Where DC does have large-investment startups is in telecom services. While VCs may be becoming a bit more conservative when it comes to those companies that need $100-$400 million, they also see a ravenous global market for bandwidth which keeps them interested.

Among US regions, Greater DC saw the highest percentage growth, both for dollars and number of deals over last quarter. Accelerating that growth, according to the panelists, has been the increasing number of local serial netpreneurs, growth in the local angel community, the increasing sophistication of local service companies and the fact that cashed-out technology veterans are staying here in the region. And itís all happening, according to Walker, at a time when we havenít even begun to tap some of the regionís greatest strengths. He urged netpreneurs to build bonds with the many local universities, federal laboratories and trade associations.

The panelists also discussed the pros and cons of other resources available to local netpreneurs, including venture fairs, incubators and the heightened activity by corporate venture funds. Use them, but be careful, especially of the corporate funds. They can be good or bad, depending upon your immediate and long-term goals. All money comes at a price, and sometimes that price can be too high.

All in all, it seems Nasdaqís bark may end up being worse than its bite, at least for startups and at least for right now. The "gazunk" of Spring 2000 may have been bigger than some of those others, but, said Walker, "at the time they happened, it wasn't clear whether the bubble had burst then. The fact is, these things happen in cycles."

And speaking of cycles, on June 1, the day after the event, the Nasdaq was up 181.59 points. On June 2, it was up 230.88 points.

Whatís the opposite of gazunk?

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