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shaking the moneytree 3: Q1/2000

has the bubble burst?  

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Mr. Walker:  I have to agree with both Pat and Patty, but let me add a little bit of perspective.

          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.  We were going to go out on the road show on the 16th of July¾we had to get the road show done so that we could price before the last two weeks in August, which are the dead weeks.  We had started in May, and we were on a crash program to make this happen.  The 4th of July was in the middle of the week, and, on July 5th for some reason, the market went gazunk.  We had meetings, and everybody said, “That's okay, it will be better by Tuesday.  On Monday it went gazunk.  On Tuesday it went gazunk.  There were four or five gazunks.

          The investment banker sent me off to Minneapolis to talk to somebody there, a real hard-nosed guy, to bring me down to earth.  We ended up postponing the IPO until September, and we actually used those six or eight weeks to get a lot of things done that we needed to, like work on the fundamentals of the company.  The question was, “What happens if you can't go public in September?  What do you do then?”  That was probably the most trying time in my life, business-wise.

          It's useful to go back and read some of the books that are floating around which talk about problems that happened in 1997 and problems that happened in 1998.  I will say that this gazunk has been bigger than some of those others, but, at the time they happened, it wasn't clear whether the bubble had burst then.  I was there in 1994 and 1995 trying to build a company that we hoped to go public with some day.  You really had the feeling, in the early part of 1996, that the bubble was going to break because it had been going on too long.  The fact is, these things happen in cycles.  This one was worse than most of the others have been, but it's not the end the world.  The fundamentals of our economy are just as solid as they have ever been.  Remember, the Nasdaq has come down from an all-time high in March.  When you think about all that craziness the six months before when the Nasdaq was going up, it's not very far off from where it was the previous September.

          It is healthy to have these cycles that slow things down.  We are taking a hard look at deals now, harder, perhaps, than we did before.  In the car on the way over here, we were talking about where we see the real problems happening¾in the companies that have been moving along for a year or so, maybe they have even had two rounds and they now need another one.  Some of these companies aren't going to do IPOs; they are going to get bought.  The trouble for the investor is, if I invest now, at the valuation that this company appears to have, and they end up in three or four or five months getting bought for even twice the present value, that's not the kind of return that we are looking for.  There will be some hard times both for companies just getting started, and hard times for companies that are moving along, but I don't think there is anything wrong with what's happened.  I think it's actually a very healthy thing, and, as Patty and Pat said, we are going to look harder at the fundamentals of companies.  In the long run, this is all going to be just another one of the cycles because the amount of money flowing into the stock market from 401Ks and everywhere else has got to go somewhere.  That $17.2 billion in venture capital is a big chunk of where that money is going, and it's going to keep doing that.

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the regional perspective

Mr. Ayres: I'd like to shift to a regional perspective and, yes, we are going to find out the answer to Fran's introductory question.

          Silicon Valley and New England witnessed the most activity in terms of dollars and deals once again.  I believe that in all six years of the survey, these two regions have consistently been at the top.  The DC Metroplex, however, once again broke quarterly records with $842 million invested in 84 companies.  Now, although DC consistently ranks sixth in our survey, its growth is notable.  Based on five consecutive record-breaking quarters for dollars invested, it is clear, at least in our minds, that the region has begun to reach a critical mass, to a certain extent.  As evidence of this, when comparing Q1/1999 with Q1/2000, the Greater DC market grew at a faster rate, in both dollars and number of deals, than Silicon Valley, New England and the Southeast, which has been coming on strong recently.

          After looking at these numbers, and taking into consideration your previous comments about the state of the market, are we ever going to see a day when the Greater DC region has the level of magnitude in deals and dollars as Silicon Valley or Boston?

Mr. Walker:  I hate this question because I don't think it makes any sense.  Let's understand, Silicon Valley has been at this since the early 1970s.  It has massive investments in companies that need huge amounts of capital in order to make things happen.  Boston has been around since the Tea Party.  I spent a long time in Boston, and Route 128 has been under continuous construction for 60 or 70 years now.  They have MIT and Stanford, places that spawned this back when it didn't matter and nobody cared about it.

          We haven't been at this for very long, yet we’ve had phenomenal growth here.  I don't think we'll ever get to Silicon Valley; I don't think we'll get to Boston.  Clearly, at the rate we are going, we are going to overtake several of the other regions and move up a couple of notches, but it doesn't matter.

          What's happening here is different from what's happening in Silicon Valley or Boson.  It's based on the core technologies we have here in the telecommunications and Internet spaces, and those folks are here to stay.  America Online may fluctuate back and forth between New York and here, but there is going to be a hard core of folks based here.  The other thing that's happening is that the millionaires who are spinning off new companies from those big successes are going to keep on doing that kind of thing.

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          It's an incredible tribute to and the various activities that are causing entrepreneurs and people with money to get together.  We keep talking about what it takes to build a fire.  You need something that will burn, you need oxygen and you need some heat.  It is programs like and various others that are creating the heat and causing this fire to burn.  We shouldn't worry about where other people are.

          I'd like to take just a moment to plant a seed in among the trees here.  It looks like we each have about $10-$12 million to give away today.  I'm not sure how far it will take you, but in the last month or so, I have been approached by four different universities in the region saying, “We have to find a way to get industry more involved with what's going on at the universities. It's a fascinating thing that's happening.  We were in College Park talking to people at the University of Maryland yesterday, and we are going to talk to George Mason University next week.  We have enormous resources in this region that we haven't made use of.  What happened in Silicon Valley started, in large part, because of Stanford University and their approach to letting their professors start companies. What happened in Boston is the same kind of thing with MIT and other schools.  We haven't taken advantage of that, and we have an incredible opportunity here.  I want to challenge all of us working through the high-tech councils, or whatever else is the appropriate venue, to find ways to link up companies in this region with the universities and to help make things happen.

          We have another resource that we need to bring into this: the federal labs such as NASA, NSA, NIST, the US Army and Navy.  There are enormous resources in this region that we need to tap into.  They have charters that say they have to do technology transfer.  Having been at some of these places, I suspect they don't quite know how do that, and neither do we, but we can figure it out.  What I see happening is a set of forums held at the universities and the agencies where they present their ideas and we come back to them with our needs.  I think this could be a second wave for this region.’s bringing the dollars and the entrepreneurs together has been an incredible thing.  We're seeing the results of that and it will continue to grow, but we can expand it even more if we can find those linkages with universities and agencies.  I'm very high on this region and what we are able to do here, and I don't care what Silicon Valley does.

Mr. Ayers:  Patty, do you have a response to this question that doesn't seem to make any sense?

Ms. Abramson:  I agree that it doesn't make any sense.  I think that we are competing with ourselves, not with the other regions.  You have to look, first, at our growth against ourselves, then at whether people are staying here.  When people cash out of companies or leave to start another business, they are starting them in this region.  That's the best report we have for where this region is going.  Five years ago that wouldn't have been the case.  If you were going to start a technology company then, you wouldn't have started it here or you wouldn't have stayed here.  You wouldn't have assumed that you could find the best workers here.  Now, we are seeing that.

          We are also beginning to see technologies, as Steve says, coming out of the government.  We have two companies in our portfolio, one that came out of NASA, another one that came out of NIH.  We weren't seeing that five years ago, except, perhaps, in the biotech area, not in information technology and telecom.

          When things start falling in Silicon Valley, they are probably going to start falling here, as well, because we are all doing the same thing.  What we want to see is that our growth is exponential against our own statistics.

Mr. Kerins:  I agree with what the others have said.  I do think there are probably some infrastructure challenges that exist in the region.  Anybody who drives around I-495 here in the morning or afternoon¾or just about any time other than between 12:00 and 12:15¾understands that there are plenty of infrastructure challenges that need to be overcome.

          The services industries in this region have changed light-years in the last five years¾the way landlords deal with early-stage tenants, the way the accounting firms and law firms have made themselves more flexible¾that’s all part of the learning and development that, as Steve pointed out, has been going on much longer in Silicon Valley and Boston.  I think we are going to do just fine.

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the early-stage bird gets the worm

Mr. Ayers:  One criteria that the survey looks at is the stage of deals that are getting done in a particular region.  For the DC metro area, we see, again in Q1/2000, large sums of money pumped into early and startup stage companies.  For the past two quarters, 58% of all deals went into formative stage companies.

          Is the region going to continue to see this level of investment specifically in early stage deals?  Are there certain sectors of the market where you are now less likely to invest, particularly in early stage companies, based on your earlier comments about the state of the market right now?

Ms. Abramson:  I think we will continue to see a lot of money going into early stage companies for a couple of reasons.  There is a lot of money out there, including a lot of people who have exercised options and cashed out.  There are a lot of people making a lot of money, even in professions that, historically, weren't thought to be the kinds where people made huge chunks, such as law firms and accounting firms that are taking equity instead of fees.

Mr. Ayers:  Not this accounting firm.

Ms. Abramson:  You are seeing a lot of people becoming angels, and, when you look just at what's happened in this region, including the number of angel groups that have sprung up, that money is going into early stage deals.  We have WOMENAngels which is the first women angel club in the country¾85 women investing in early stage companies, not necessarily women-led companies, but early stage companies.  I know that Steve is running one in Maryland, and you have The Dinner Club, The eMedia Club and others.  That's a lot of money going into early stage companies.

          Additionally, 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.  When we started our fund, we only had $30 million under management, and we assumed that we were going to invest in this region in somewhat later stage deals.  Well, we're finding ourselves going in earlier and earlier, first, because of the valuations, and, second, because of the size of the piece.

          We are also seeing something that we hadn't seen much of in this region before, serial entrepreneurs.  We are seeing a lot of people cashing out or running companies, then coming back and starting companies again.  Those companies have an easier time getting backing.  We saw it in Silicon Valley and we saw it in Boston, but we really hadn't seen that here.  We are seeing a lot of young entrepreneurs who have done it before and are out there raising money again.  Most of us want to back them.  They have a track record and we want to back them, so we will back them early.

Mr. Ayers:  Are there certain sectors where you are less likely to invest in these earlier stage deals now because of the market?

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Ms. Abramson:  Sure, including companies in the sectors that take enormous sums of money to get them up, most notably the B2Cs.  We originally thought, “Gee, the Internet is just going to solve all the problems.”  We didn't realize things we should have realized, like this is just another means of distribution.  It wasn't just going to be bringing eyeballs to the site; it was going to be a matter of who is going to purchase goods and services and how are these companies ever going to make money?  When we look at companies that are going to take enormous influxes of cash on a continuing basis to get them to profitability, or even to get them to break even, we are very wary about investing in those sectors.

Mr. Walker:  I certainly agree with what Patty said and would reinforce it.  B2C is a difficult area to be in.  Lots of people have been at it for quite a while, it has huge marketing expenses and it’s not clear who is going to win.

          What we find fascinating are companies where someone or a group of folks understand a particular space or a particular business, and they are applying the Internet to bringing significant efficiencies to that business space.  It’s not B2C, it's B2B, it's whatever it is, but knowledge of a particular business area, coupled with knowledge of the Internet, can make a dramatic business for very little investment.  I think this is another reason why we have an advantage over Silicon Valley and other places.  A lot of the things we are doing in this region don't require a lot of capital.  They require some innovation on the part of a few people, then they need to be able to grow the company, but they are not talking about putting in massive amounts of investment.  It’s another reason why I think this region is going to do well.

Mr. Kerins:  As Steve points out, for many, many business plans, you see companies that could create potentially multi-billion dollar public companies on $3-4 million with a dozen people.  That’s become a very attractive place for venture capitalists to go, and that probably skews this chart a little bit.

          The other thing that skews it a little bit is that there have been a lot of investment in pre-revenue telecommunications services companies, such as Pathnet in Washington, DC, where we have an investment.  There has been a total of almost $400 million invested in that company before there was a penny in revenue.  If you call those “formative stage companies” in your survey, then the combination of the region’s strengths in Internet and telecom probably skews this to early stage numbers.  Those areas are great strengths of this region, and there is great potential for future markets.  There appears to be no end to the need for telecommunications bandwidth in this country, and around the world, so putting together smart groups of people and large amounts of capital to pursue that opportunity continues to be a good investment.  There is some tentativeness, right now, about business plans that require one, two, three, four hundred million dollars.  It's uncertain where those kinds of financings are going to come from in the near term, but I think this region is going to continue to be strong in those two sectors and will continue, if you categorize it the same way, to have 50%, 60%, 70% of the money going into formative stage companies.


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