Nov. 6–VENTURE CAPITALISTS HOPEFUL OF UPSWING IN BUYING START-UPS: If the buzz about a pickup in corporate spending is true, venture capitalists might soon be able to save their hides.
They’ll finally be able to sell some of their start-ups for a profit.
Still, there are a number of bottlenecks in their way.
First the good news: Analyst firm IDC predicts next year will see the first significant increase in technology and telecom spending — 5 percent — by companies since 2000. Some VCs believe the increase, combined with the boost in company’s share values on the stock market this year, will spill over to more acquisitions of start-ups.
On Wednesday, that thesis was given more life. Norwest Venture Partners, of Palo Alto, saw Network Appliance gobble up one of its portfolio companies, Spinnaker Networks, for $300 million — one of the bigger tech deals recently.
“The recovery is going to hit us like a two-by-four in the face,” 3Com Chairman Eric Benhamou said this week. His remark, albeit referring to the semiconductor industry, came at a technology conference in Burlingame that was sponsored by VentureOne and Ernst & Young.
The data still doesn’t show an uptick in acquisitions, according to John Gabbert, director of research at VentureOne, even if conditions seem ripe. Like other people at the Burlingame conference, he recounted a list things preventing a binge for now:
— The books — Post-Enron and WorldCom concerns for clean financial books, and the recent Sarbanes-Oxley legislation, mean companies are taking longer to kick tires before acquiring. Ernst & Young’s Bill Tulin said his company’s due diligence practice is running “40 percent ahead of plan.”
Toby Coppel, Yahoo’s senior vice president for corporate development, said Yahoo recently dropped plans to acquire a start-up that hadn’t invested in getting its books in order. He said too many start-ups are channeling the VC money they get into sales and marketing, to the neglect of the back office.
— The DNA — Coppel said big companies like his are taking more time to make sure the “cultural fit” is right.
When asked about Yahoo’s plans for acquisitions next year, Coppel sighed, saying Yahoo has enough on its hands after its acquisitions of Inktomi and Overture. Those companies each have different styles and technologies, and it could take a while to integrate them.
Jnan Dash, technology consultant for Sunnyvale start-up KnowNow, said that Oracle — where he formerly worked — rejected 99 percent of the companies it looked at “because the DNA didn’t match up.”
Especially in the software industry — a relative strength of Silicon Valley — it’s almost impossible to merge software code, Dash said. “It’s like crossing a cow and a crocodile.” The hope of many struggling start-ups that they might get acquired is so much wishful thinking, he said.
— The lawyers — Many start-ups are intimidating in their legal complexity.
During the downturn, many venture capitalists, afraid of investing at a time when most companies were going out of business, secured their investments with so-called “liquidation preferences.” These clauses guaranteed that, in the event the start-up was sold, the VCs would get their money first — before other executives or employees.
This sets management and employees at odds with the venture capitalists, and it is one reason Jeff Herbst, vice president for business development at Santa Clara’s Nvdia, said his company has avoided acquiring start-ups with such preferences. The start-up’s employees won’t profit, and so won’t take kindly to the merger: “The smart ones will say, `What’s the point?’ “
Owen Mahoney, VP of corporate development at Electronic Arts, agreed. “Many deals fall apart on their own complexity,” he said.
Wayne Lieberman, general manager at Marvell, a Sunnyvale semiconductor company that is one of the valley’s fastest growing, said acquisitions these days can often mean negotiating with twenty lawyers. VCs, employee groups and management each hire their own, he said.
— Early stunting — Lieberman said another count against acquiring U.S. start-ups is that they’re being starved of seed capital. Marvell has looked abroad, to Israel and Germany, and made three acquisitions, Lieberman said. Foreign governments tend to support their companies with more seed funding, he said. Even in Silicon Valley, which is relatively awash with venture capital, Lieberman said companies with four or five employees are having trouble getting initial funding. “When you’re talking about seed money, and you’re adding in `show me a customer,’ it makes it kind of tough,” Lieberman said.
Many of these pitfalls are legacies of the Internet bubble, when start-ups got so much cash they got spoiled, and venture capitalists got greedy.
That’s why Norwest’s Spinnaker offers so much hope. It stayed focused, building a network-attached storage (NAS) product that enjoyed real sales. It got its books right. Liquidation preferences didn’t spoil the deal. What’s more, it was negotiated within two months, and without an investment bank. That’s all rare for vintage year 2000 investment. “The economy has been a great boot camp,” said Norwest partner Matt Howard.
Contact Matt Marshall at [email protected] or (415)477-2518.
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