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shaking the moneytree 3: Q1/2000

has the bubble burst?

In the first quarter of 2000, venture capital investments hit another all time record according to PricewaterhouseCoopers’ (PwC) MoneyTree™ survey.  As the quarter aged, however, the stock market fell hundreds of points, and worst hit were many of the high-flying Internet companies.  What does it mean for netpreneurs seeking funding?  Has the bubble burst?  The effects will be felt, said leading VCs at this co-sponsored event held February 29, 2000, but their outlook remains bullish.  VCs may become a bit more conservative about valuations and more thorough about due diligence, but, in the long run, that’s a good thing and the money will continue to flow.

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

Commentary:   Kevin Burns, Lazard Technology Partners
Karl Khoury, Columbia Capital

Roger Novak, Novak Biddle Venture Partners

Moderator:  Carl Grant, PricewaterhouseCoopers

fran witzel: welcome

Good morning and welcome.  My name is Fran Witzel, Vice President of Morino Institute's  We invite you to join our .org community for .com startups where you can participate in creating the New Economy with Greater Washington's emerging Internet companies and experts from around the world.

          This morning, it's our pleasure, in partnership with PricewaterhouseCoopers (PwC), to welcome you to Shaking the Money Tree where we will review venture capital investment activity in the first quarter of this year in our region.  The results were no less than phenomenal.

          Just how phenomenal?  As a pre-test, let's compare our region to Boston and Silicon Valley.  Which of those three regions do you think had the highest percentage increase in both number of deals and money invested in the first quarter of this year, compared to the previous year?  We'll soon find out the exciting results.

          Indeed, these are exciting times, perhaps a little too exciting.  More and more corporations are getting into the game with their own venture capital funds and incubators.  However, despite the fact that new incubators and accelerators seem to be announced every day, just last week, Divine Interventures laid off 29 people, raising speculation that they may withdraw their filing to go public.  Initial public offerings have slowed down to a trickle, and stock markets and valuations have rediscovered gravity.  More and more .coms, both public and private, are battling for survival.

          So, where have we been and where are we going with venture investment activity in our region?  We'll find out from PwC and our distinguished panel.  These panelists are making many dreams come true in Greater Washington by partnering their money, expertise and networks with great management teams to help build high-growth companies.  We are glad that they are here with us this morning.

          Introducing our speakers and moderator will be Kris Muller, a partner with PwC's Global Technology Industry Group in the DC Metroplex area.  She previously serviced the Stanford, Connecticut office, where she was a founding member of PwC's Internet practice.  Kris has more than 15 years of experience, including delivering a variety of services to both rapidly growing and Fortune 500 companies.  Her past responsibilities have required constant interaction with her clients on a variety of technical issues, including business planning, financing alternatives, revenue recognition, stock-based compensation, mergers and acquisitions, initial and secondary offerings and private placements.  Her key clients, past and present, include Ciena, Proxicom, Main Control, Interworks, Praxair, IBM, Compaq, Alta Vista and Kodak.  Please help me to welcome Kris Muller.

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kris muller: introductions

Yes, Fran, the IPO market is definitely trickling, 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 expect¾the infrastructure, software and technology companies that are helping to build the Internet, and the Internet isn't going away.  Business-to-business (B2B) is out there, so I don't think we're seeing it shut down.  It’s just being very conservative and being very smart money.  What you will see from the MoneyTree™ survey today is, likewise, a lot of very smart talent still focusing on the region and the industry.

          I have the honor of introducing our three panelists today, and they are a tremendous group.  These are folks from three of the most active VCs in this quarter, so they are the ones who are actually making the deals in the area.  Hopefully, they will be able to impart some of their light, as well.

          The first person I would like to introduce is Patty Abramson.  Patty is the managing director of Women's Growth Capital Fund, which she founded here in Northern Virginia in 1997.  Patty manages the fund on a day-to-day basis¾seeking the investment opportunities, doing that scrutiny and looking for the next big winners.  She works with portfolio companies using the 25 years of diversified experience that she brings to the table.  Prior to Women's Growth Capital Fund, Patty was the president of Abramson Communications and a partner and CFO of Hager, Sharp & Abramson, both communication companies in this area.  Patty has received national recognition for work on behalf of national women's organizations, as well as political, economic and social issues.  She gets a lot of press and appropriate visibility in and around Northern Virginia.  She is a former delegate to the White House Conference on Small Business and has been Small Business Advocate of the year.  She has a BA and an MA in journalism, so, when you send in those business plans, she knows what she is reading and can tell the fiction from the nonfiction.

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          Our second panelist is Pat Kerins, a managing director and principal technology investor for Grotech Capital Group where he's been since 1997.  Prior to joining Grotech, he had 10 years of doing investment banking at Alex Brown, specializing in high-tech companies. Patrick was also a consultant with McKinsey & Company working on strategy products with global technology companies.  He has a BS from Villanova University and an MBA with distinctions from Harvard.

          Our third panelist, Steve Walker, is a principal of Walker Investment Funds and President of Steve Walker & Associates.  Prior to that, Steve was president and CEO of Trusted Information Systems (TIS).  In 1983, he made a wise investment of $30,000 in Trusted, and, less than five years later, walked out with a $350 million company.  Pretty good growth returns there.  Steve's background is in network security and advanced R&D. Through Trusted, he worked with some of the world's most secure firewall and encryption software.  Steve has 22 years with the Department of Defense working with the National Security Agency, Office of the Secretary of Defense and the Advanced Research Project Agency.  If you put all those initials together, Steve is probably one of the few people who actually can tell Al Gore, “I did invent the Internet.”  He worked on the ARPANET project breakthroughs, which are the backbone to the Internet as we know it today.  He has been recognized with the Secretary of Defense Meritorious Civilian Service Award, National Computer Systems Security Award, Federal Computer Week's Federal 100 Award, KPMG Entrepreneur Award and the list goes on.  He testifies before Congress and is an accepted expert in information security and technology policy.  I guess he probably doesn't make a lot of investments in retail and apparel, but he can shed a lot of light on VC money coming into the area for technology.

          As you can see, it's definitely an esteemed panel that we have here.  I want to introduce one more person in the audience, I will call him PwC’s all-knowing person of the MoneyTree survey.  From our Texas area, Kirk Weldon is our national director of the survey and has been building the database and survey from its infancy.  Kirk, thank you.  He also works with our survey group on our national base, and a lot of the survey team is here today.  We welcome you all.

                It’s time for me to get off the stage and introduce another member of PwC, Erik Ayers, Business Development Manager of the DC Metro TICE Practice, who will be our moderator and put the panelists to the test.  Erik is part of the PwC V-Team, the “V” standing for our venture capital group.  Erik has been with our office for several years now.  He works closely with VCs in the area, but he also networks with the companies, entrepreneurs, our practice and other practices to bring the elements together¾the ultimate matchmaking to make sure we are bringing the right deals and getting the right information to the community.  Erik, I'll hand off to you.

the panel: first quarter of a new century

Mr. Ayres:  Good morning.  Thank you, Fran and Kris.  During this morning's program, I'm going to present a series of slides covering key points from PwC's Q1/2000 MoneyTree survey.  After each slide, I'll ask the panel questions to gain their insights and interpretations of the data.  We are then going to take a quick look at some of our panelists’ specific portfolio investments from Q1/2000 and, lastly, take some time for Q & A at the end.

          Before we jump into the data, however, I want to mention a couple of key points about the MoneyTree survey, now in its sixth year.  Each quarter, PwC surveys over 850 venture funds from across the country.  The survey tracks quarterly investments in US companies by region, industry and stage, as well as other criteria.  For any venture funds that have not had the opportunity to participate in the survey, I encourage you to do so.  We make it very easy for people to participate, and it can be completed online.

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has the bubble burst?

Mr. Ayres:  The first quarter of 2000 marked another record-breaking quarter for venture capital nationally¾$17.2 billion was invested in over 1400 companies.  This amount exceeds last quarter's investment by 17%.  However, as you can see by the chart, growth seems to have slowed down.  Between Q3/1999 and Q4/1999, dollar investments grew by 65%, compared to 17% for this quarter.

          Some interesting comments here.  When our panelists at last quarter's Shaking The MoneyTree event (2/29/2000) were asked the question, “Do you see any end in sight to this astronomical growth?,” they made comments such as these:

-     “'s a great time to be an entrepreneur because there is more money available than ever before.”

-     “The bubble bursting is just kind of laughable to me.”

-     “Actually, I believe that we are really just getting started.”

-     and “The fact of the matter is, until the returns are no longer there, the successes will drive the momentum and people will continue to invest in technology.”

          Well, three months have passed since our last Shaking the MoneyTree event and, since then, we have seen headlines such as: “IPOs Are DOA,” “The IPO Crash Diet” and “Money Supply Tightens for .coms.”

          In light of these comments, did the bubble burst, and do these market changes signal that the venture capital well is now beginning to run dry for our region?

Mr. Kerins:  I think there has been a reasonably significant bursting of the bubble, so the answer to the first question is yes; however, the answer to the second question is no.

          Most venture capital firms are fundamentally portfolio managers who manage a portfolio of private equity investments.  Most of us who report quarterly numbers to our limited partners are going to report a quarter in June that is pretty bad.  The Nasdaq is down more this quarter than it was in the quarters surrounding the so-called crash of 1987, and most of the returns that are baked into the apparent paper profits in the IRRs of venture firms are a result of holding early stage Nasdaq companies, most of whom have had some serious corrections.  Most of us have seen lots of apparent paper profits turn into apparent paper losses this quarter.  As a colleague of mine said the other week, “The mistake I made was thinking it was my money.”

          I think the mood in most firms is negative as a result of that; however, I would say that most of the reported returns in firms are still above target returns when the funds were raised, so, in essence, we have the same situation in venture capital firms that we have in the stock markets today.  While the Nasdaq and Dow have corrected substantially with regard to, let's say, the last major correction that people in the investment world today lived through, the one in 1987, the mood is still way better now than it was a quarter after the crash of 1987.  That has to do with the fact that we were probably just up a little too much.  For people who have been in the financial industry for a while, that appears to be an unsustainable chart, so, in that sense, I think the bubble has burst.

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          Will it slow down investment activity in this region?  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 deals¾more now than there was a quarter ago.  What we have seen, and we closed two deals last week, is that the area under the demand curve is the same or larger than it was in Q4/1999, as far as total amount of funds, but the shape of the curve has changed substantially.  There is greater demand for lower valuation deals and deals where there is a greater sense of financial substance to the company.  There has been almost a complete closing of the faucet for the so-called “pre-IPO investment round,” the late-stage rounds at very large valuations where the timing, valuation and schedule for the deal is all based on a predicted IPO.  That’s because, as was pointed out in Erik's comments, predicting IPOs these days is a fool's game.

          My sense is that the deal flow and the willingness of firms to close on deals in this region have 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 .7 X, and is going to take his or her time to close a transaction.  Venture firms are in the same mode, but I think you will see deal volume continue pretty strongly because the basic demand for deals as represented by the funds under management is still large.

Ms. Abramson:  I agree with Pat in terms of the bubble bursting, but I liken where we are to what happened with the real estate boom in the 1980s when you saw people stuck with a lot of land and not a lot of cash.  You would ask things like, “What were the banks doing lending all this money to these companies without any collateral?”  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.  Looking at some of the pricings six months or a year after they went public shows that.

          It's making us look a lot harder at the investments before we make them, and it's making us look a lot harder at the valuations.  Once we were going through a period of saying, “That's okay; we are going to make it on the next round.”  Now we are looking very closely at those numbers and asking, “Are we going to make it on the next round?” and “What does this company have to do between now and the time it raises the next round to get that valuation up?”  A year ago they almost didn't have to do anything but go out and raise the next round and you saw it in huge multiples.

          While it makes me nervous as I look at all of our portfolio companies, and I get a little nervous about writing that letter to our investors about this quarter versus last quarter, I still think that these companies we have, if we have made good investments, are going to get there.  They are just going to get there a little slower and maybe they are going to get there a little healthier.


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