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perspectives on venture capital in greater washington

shaking the money tree

Only a handful in a hundred entrepreneurs actually end up getting venture capital, according to's Fran Witzel, and that fact highlights how astounding recent venture funding statistics have become. Each quarter, PricewaterhouseCoopers (PwC) reports the results of its MoneyTree™ survey, and 1999 was another record breaking year in which Q4 deals alone outstripped all of 1998. At this co-sponsored event held February 29, 2000, results for 1999 were presented and commented upon by a panel of leading venture capitalists, with special emphasis upon their implications for the Greater Washington region and how the pie can be made even bigger.

Copyright © 1996-2003 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. I'm Fran Witzel, Vice President of Morino Institute's We invite you to join our community for startups, where you can get to know Greater Washington's emerging Internet startups and learn from people around the globe who are creating the business rules for the New Economy.

It's our pleasure, in partnership with PricewaterhouseCoopers, to welcome you to Shaking the Money Tree. Today we will review venture capital investment activity in the Greater Washington region during the final quarter of 1999.

To quote The Killer, Jerry Lee Lewis, there is a "whole lotta of shakin' going on" with another record-breaking quarter based on PwC's latest MoneyTree™ survey. There were more deals and more money invested than at any time before. Was this all about money? The woman back there who had a ton of webMethods at the offering price is shaking her head yes.

Will every business get venture capital? The odds are that only a handful out of 100 companies or more actually will. Just what is venture capital and who are these venture capitalists anyway? Steve Harmon puts it this way in his book Zero Gravity, "The bumper sticker for the 21st Century info entrepreneur is 'Get big fast, and then get bigger.' To do just that, more and more, garage and grunge heroes turn to venture capital. It can provide not only money, but also allies, partners and a fast track to an initial public offering (IPO) or sale to a larger company. The venture capitalists, VCs in finance parlance, are now the power brokers, banks, management providers, gurus and even mothers who hold the hand of the newbie ideaites and take them past the training wheel stage into rocket racers. It's "smart" money, the people and their capital, and it has to be smart. There is no time to make the wrong moves in a world where every great idea has a half dozen imitators within 60 seconds."

To give us their commentary, insight and answers to your questions about PwC's MoneyTree survey results, as well as other venture capital investment issues and trends, we are very fortunate to have a distinguished panel of successful VCs who are based in our region. Our panel will be introduced by Bill Bishop. Bill has been a partner with PwC since 1988, having served clients ranging from small, privately-held companies through large, New York Stock Exchange corporations. A native of Birmingham, Alabama, Bill has been based in Atlanta, Birmingham and Memphis. In September of 1999, he, his wife and two teenage daughters moved to our community, and Bill has assumed responsibilities as one of the leaders in PwC's DC Metro Technology, InfoCom, Entertainment and Media (TICE) practice, based in Tysons Corner, Virginia. With plenty of experience with emerging technology companies, including duties as a regional Securities & Exchange Commission (SEC) reviewer for client SEC filings, Bill is someone that I know many of you will want to get to know. To tell you more about the MoneyTree survey and introduce our speakers, please help me welcome Bill Bishop.


bill bishop: introductions

Good morning. Fran, thank you very much for that introduction. I'm glad to be here this morning. As Fran said, mine is a new face around here, and, after being here for six months, the only thing I can say is, "Wow, what a place to be!" There is so much going on, so many things happening. The fact that we have a crowd like this is a great indication of everything that is going on in this marketplace.

On behalf of PwC, I welcome you to this presentation of Shaking the Money Tree to hear about the most recent quarterly MoneyTree survey. Without further ado, I would like to introduce the participants in today's program and we'll get right into it.

On my immediate right we have Karl Khoury, who comes to us this morning from Columbia Capital. He was with J.P. Morgan & Co. before joining the VC community, and he sits on the boards of several local companies that Columbia Capital has invested in. Karl, we are glad you are here.

Next is Kevin Burns with Lazard Technology Partners. He is also fairly new to the capital investment market, although he has been in the technology marketplace for a long time. He started his own software company, INTERSOLV, in 1982, which was before many people in this room had ever heard the word "technology," much less "venture capital." He is on the boards of a number of Lazard portfolio companies and on the board of the Mid-Atlantic Venture Association, both of which we'll hear more about later.

Finally, on the far right, Roger Novak comes from Novak Biddle Venture Partners. Roger has been in venture capital for 20+ years and is one of the founders of that marketplace.

Gentlemen, we are glad to have you with us this morning. We look forward to hearing your comments about the MoneyTree survey and what's going on here specifically. To get us started, let me introduce Carl Grant, "The Rainmaker" of PwC's VTeam, our venture capital team, and moderator of today's discussion.


the panel: the internet forest and the money tree

Mr. Grant: Each quarter PwC surveys over 800 VC firms for our MoneyTree report. By using consistent methodology, we are able to capture accurate trends and changes over time. The survey, which can be completed online, is in its sixth year, and the results are available at

The format today is going to be interactive. I'll be presenting about half a dozen data points looking at the national picture, regional comparisons and local trends. After each, I'll ask our esteemed panel for insights and interpretation of the data. We'll also take a look at portfolio investments from each of the VCs represented here, and then I will open the floor to audience questions.

a record year for venture capital investments

Mr. Grant: Investments during just the fourth quarter of 1999 exceeded investing that took place in all of 1998. VCs pumped $160 million a day into emerging technologies during the fourth quarter, putting the survey results at a record $14.7 billion, and hitting an unprecedented $35.6 billion for the entire year. Ninety percent of the investments went to technology companies, over half to Internet companies.

Roger, Kevin and Karl, I get asked all the time when I think the bubble is going to burst, so I would like to ask each of you whether you see any end in sight to this astronomical growth in private equity investment? Roger, would you start?

Mr. Novak: There are two things I want to say. First, it's a great time to be an entrepreneur because there is more money available than ever before. Second, it's a great time to be a venture capitalist because, historically, it took four to five years to get a company to the public equity markets. Now, in some instances, from startup to an IPO takes two-and-a-half years—and you don't have to show profits.

Is there an end in sight? It's beginning to look a lot like the biotech industry, and, interestingly, we are now beginning to see some discrimination from the institutional investors who buy the public equities. An interesting item I have seen is that LifeMinders just came back from a secondary offering in which they raised over $100 million, but the tenor of the institutional investors is now, "When are you going to turn a profit?" and "If you have to shut down your spending, what's going to happen?"

What has been driving a lot of this appetite in the private sector is the public equity markets. If you can get to the public equity markets, you have virtually a zero cost of capital, in many instances, and the people who get there, particularly the Internet companies, are just recycling dollars by advertising on other Internet companies. However, I'm beginning to get a hint that there is some discrimination among the institutional investors, and I think that if you look at what's happening in the public equity markets, some of the high fliers are off 30-40%. That will eventually work its way back through the private sector.

Mr. Grant: Kevin, do you have a different view on this?

Mr. Burns: Actually, I believe that we are really just getting started. The public markets will have their ups and downs in valuations, but I'm not really commenting on that. What I'm thinking about is a fundamental business issue—I believe that private equity is going to be the big "killer app" of the investment equation for the next 10 years.

You have to contrast today with times when technology architectures are very stable, such as during the long run of IBM mainframe computers through the '70s and early '80s. Everything was known, then. IBM provided the hub and mother mainframe was home base. Technology changed, but it didn't change very radically or very dramatically. Then came the client/server area—fat client/server, then thin client/server, now over to the Internet and then wireless and on and on—there has been a radical change in the technology-enabling infrastructure. It is empowering a lot of entrepreneurs and other people to go on the attack against the big incumbents. Big, stable companies have an advantage when technology is running constant. At times of great paradigm shifts, however, the leverage all flows away from the big companies who are somewhat encumbered by their own success, by their big customer bases, their old funky technologies and the like. At those times, an entrepreneur who is fleet of foot, who can jump on a new technology, has a distinct advantage over the larger companies.

My read of the tea leaves on technology is that the Internet, wireless and communications infrastructure is changing so rapidly that we are going to have a long run during which the fleet-of-foot entrepreneurs and innovators who have the right capital, the right management and the right passion will be able to turn the tables on the large, big-branded companies throughout the world.

The bubble bursting is just kind of laughable to me. I see us just getting started. A lot of the companies I talk to are just learning what E-business really is—how to really change the way you do business. I think we are going to see a long run of the same.

Mr. Grant: Karl?

Mr. Khoury: I'm probably a combination of these two. 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. That's because, to Roger's point, the huge supply of capital in the public markets is also true in the private market. It used to take a VC firm anywhere from 12 to 18 months to raise $150-$200 million. These days, we have had people tell us they can raise a $750 million fund in three months. The supply of capital is there from the institutional market, on the private side as well as on the public side.

When will the flow of capital dry up? When the returns start to head down, all of a sudden. Until the innovation starts to trail off, until you start to flatten the innovation curve, there are going to be strong returns. We haven't even seen the second wave when all the people start coming out of America Online, UUNET and the other large organizations—people who can take the ideas they had within those institutions and implement them outside that infrastructure. I think what Roger said is right. When there is a hiccup in the public markets you are going to see a lot of this start to tail off to a certain extent, but the long-term trend is going to be very strong.

greater washington: hot or hype?

Mr. Grant: Let's take a look at regional comparisons. Silicon Valley continues to be at the epicenter of venture activity with 39% of all Q4 dollars, and the Boston area a distant second. No surprise. Those of us who work with VCs and entrepreneurs in this region feel like we are standing at ground zero for the New Economy; however, according to our survey, the DC "Metroplex" is number six in terms of dollars invested, both for the quarter and the year ($1.6 billion in 1999), behind New York, the Southeast and even Los Angeles. We rank seventh in the nation in terms of growth over last year (114% increase), and number eight in terms of the number of deals done (189).

Have we over-hyped this region, or are we experiencing something that perhaps is not reflected in these numbers?

Mr. Khoury: I think this hits the point, again, that this market is in its early stages of growth. Look back five years and there were probably—Roger, you will know—maybe four or five large VCs in the region. Today we have 30 or 35, and that may be well short of the actual number. I think that you will continue to see money coming into this region because there is a tremendous amount of deal flow, quality transactions and quality management. Where the region needs to add depth, in my personal opinion, is the management pool. In Silicon Valley there is a huge pool of talent and you cannot get people to leave. But that is going to change in this region as people start to leave some of the larger organizations. I think that we will continue to see growth.

Mr. Burns: I have about the same view; it's just getting started. We cover Boston, New York and DC. When I look at these numbers and our deal flow coming out of each of those cities, there is a disconnect. It feels like we have more quality deal flow coming out of DC than we have in Silicon Alley and New York, maybe Boston. My day-to-day experience says that I would have thought DC would be higher than New York.

Mr. Grant: Roger, I remember when you were raising Novak Biddle just a short time ago. Are these numbers about right?

Mr. Novak: I think it is skewed by a couple of things. One, existing funds have been able to raise large pools of capital, and a lot of the oldest funds in the nation are in Silicon Valley. You have seen people raise gazillions of dollars and put it out in larger chunks. I believe I saw in VentureWire a couple of days ago that it's averaging about $200+ million a day going into venture deals. So, on the one hand, you have more money going to the established funds in the Silicon Valley and Boston, and they are having to write bigger checks to get that money out.

Where do we sit in this process? Going back to what Karl was saying, if you think back seven or eight years ago, there was not a lot of activity here. It was still driven by systems integrators, in many instances, and then you began to see companies like AOL, UUNET and PSINet. We are just at the inflection point of what I think is a major curve for growth in our region.

If you look at what this area is noted for above all else, it's probably telecommunications. We have had more and more people tell us that they believe this is the telecom capital of not just the US, but the world. We think telecom is an industry that's going to continue to boom. In fact, about 50% of our portfolio is telecom, and I know Columbia Capital is that way, too. I am really bullish on this area. I think it's going to be just enormous over the next five to 10 years.

the smart money goes to smart sectors

Mr. Grant: Nationally, Internet-related companies, which cut across all standard industry categories, increased nearly sixfold from $3.4 billion in 1998 to $19.9 billion in 1999. This accounted for 56% of total investments. Our survey shows a stark contrast in the types of Internet companies that are getting funded in the DC area when compared to the rest of the nation. Take a look at these sector breakdowns:

B2B E-commerce Sites 13% of deals nationally, 9% in Greater Washington

B2C E-commerce Sites 22% of deals nationally, 11% in Greater Washington

Content Sites 17% of deals nationally, 7% in Greater Washington

Services 16% of deals nationally, 3% in Greater Washington

Access/Infrastructure: 17% of deals nationally, 31% in Greater Washington

Tools/Applications 15% of deals nationally, 39% in Greater Washington

Nationally, 51% of Internet dollars went to E-commerce and content, whereas only 23% of the funding went to those sectors in Greater Washington. A whopping 70% of Internet investments in this region went to Tools/Applications and Access/Infrastructure, compared to 32% on the national level.

I would like our panelists to help us understand the composition of companies getting funded here, and the types of companies that you are looking to fund this year.

Mr. Burns: Our major focus in this area is the telecom that Roger mentioned. We also see a lot of business-to-business (B2B) E-commerce, which is another one of our investment themes. In addition to looking at specific business plans, VCs will also attempt to look ahead and try to identify investing themes or emerging areas where they think there will be high returns. Many times, they will then marry those themes with specific entrepreneurs and business plans.

One theme we look for right now is B2B, which we think looms large. We like verticals where you can build a whole community or trading hub and disintermediate. We look for specific criteria, such as an industry that has fragmented distribution chains, lots of complex skews and for solution sets that are trying to move downmarket to the small and medium-sized business person. We see a lot of very interesting B2B, vertical communities and hubs that can provide those types of functionality.

I think the region is well suited not only to be ground zero for telecom, but also ground zero for the Internet. When you look at Silicon Valley, their base of expertise is still in some fairly funky technologies—operating systems, DBMS, enterprise grade stuff, etc. We are in a good position, here, to take the lead and grab the number one brand in the Internet and B2B. Additionally, a lot of government technologies, such as the programming languages used in the government that were perceived as offbeat in the '80s are now becoming mainstream and have central roles on the Internet. The Internet was largely born in the government and R&D environments.

Another one of our main focuses is the plumbing underneath the Internet. There is a lot of very interesting infrastructure that needs to be bolted underneath these vertical Internet plays in order to make the Internet rugged, reliable, scalable and secure. There are a lot of missing things that were taken for granted in the old architectures, and the DC area has a lot of ballast in plumbing and surrounding administrative infrastructure, in addition to its telecom base.

Mr. Novak: We are a little bit different from these other two funds in that we are 85%-90% focused on startups. We really do fund "one person in a garage" and may work with him or her for six to nine months. We also like B2B, and we like hubs, such as Blackboard, which is really an E-learning hub. We'll eventually put commerce behind it, but we led with the technology. As a fund, we tend to be very technology-oriented, so, when we look at a B2B exchange or hub, we look for an underlying proprietary technology. The same thing goes in the telecom space; here we are playing in the optical market and, again, looking for that defensible, proprietary technology. I hear people such as some of the content aggregators say, "It's the one who gets there first with the most." You are seeing people pour a lot of money, $20 million and $30 million, into startups and betting that they are going to get there. However, there is nothing defensible other than a first move advantage.

We are looking for very, very talented people. We are looking for high technical content and a proprietary advantage, then we put a little bit of money in. Our strategy is: let's prove the concept, build the team and, if it works, we'll go to the larger funds and raise a lot of money.

Mr. Grant: Karl, you are responsible for a large portion of that 17% of access and infrastructure deals, but you have also been dabbling in some business-to-consumer (B2C) E-commerce. Where do you see this going and what are you looking for?

Mr. Khoury: These sector breakdowns help you understand the regional rankings discussed previously, and why the DC market may not have as many deals or those of large size. If you look at the rest of the country, B2C E-commerce and content sites make up almost 40% of those transactions. That's Silicon Valley and New York's Silicon Alley. It's companies spinning out of NBC, Time Warner or CBS, and people throw money at the wall, $30 million at a time, saying "We're going to go out there to create a brand." Well, you can do Super Bowl ads, but I can tell you right now, I don't remember any of them. If you would like to spend your money that way . . .

Mr. Grant: Only LifeMinders', right?

Mr. Khoury: We look at a deal and ask if we're putting money into branding or, to Roger's and Kevin's points, are you putting money into a management team and an underlying technology? You can have a successful company based on brand if the team is extremely talented and can execute, but we prefer to spend our time looking within our vertical markets of communications and technology to find the companies that have tremendous management teams, a well thought-out strategy and the technology base. Then we help these teams execute their strategy.

To your point, the Torrent Networking Technologies of the world (acquired by Ericsson for $450 million in Spring 1999), which can knock out a brilliant idea with two or three engineers and who just need someone to help blow their business out, that is a very, very good business model for us. We have seen deals for $500K, $1 million, $2 million where a couple of partners in this region are working on next generation infrastructure and access solutions. However, we will also look at companies like XM Satellite Radio Holdings where we'll put $25 million into a next generation carrier if we think the public markets and the next stages of financing can bridge the company to the next level.

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