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Innovation: Start-ups, venture capitalists are waiting for the thaw
Sunday, March 25, 2001 By Bob Starzynski, Post-Gazette Staff Writer
The biggest question on the minds of those in the technology industry today is, "When?"
When will the public markets warm up? When will those tabled initial public offerings go to market? When will venture capitalists start spending more heavily again on new start-ups?
We'll throw a "How?" question in there, too. How will the technology market be different when we finally turn the lights back on?
In the past year, the technology and technology finance industries have headed in one direction -- south. How far south can the industries travel before they turn the corner?
The forecasts of most leaders in those markets is vague. We won't see things bounce back tomorrow, but the slide shouldn't last for another year or more either.
"If you use history as a guide, these [down] cycles take a year or more to wash their way through the marketplace," said Mike Nelson, a managing director of technology operating company Redleaf. "We'll look toward the end of this year for things to return to favor."
"A lot of investment bankers are talking about the IPO market opening in the second half of this year, but it really depends on larger economic trends," said Marlee Myers, managing partner of the Pittsburgh law office of Morgan Lewis & Bockius.
"The public markets have been burned a bit by a lot of early stage companies with unproven business models," said Tim Slevin, an analyst with investment bank Parker/Hunter. "You tend to see several quarters of economic cooling when that happens. It will probably be at least a couple of quarters before you see things pick back up."
So, assuming that we can look for brighter skies by Halloween, we can be sure of one certainty when that time comes: the public market for technology stocks is going to be a much different game than it was a year ago.
Even though the market will be more friendly and generous than it is now, investors will be wary with a once-bitten, twice-shy attitude. The rules of the game will be different.
Gone are the days when a company with no revenue and no clear plan for profitability could go public and enjoy a 400 percent run-up on its opening trade.
"When the market opens, there will be some definite changes," said Myers. "Unproven companies won't be able to [succeed] on the public market."
When we do see the next slew of technology IPOs, consumer-oriented Internet companies will likely not be among the group. Nor will small service providers of Internet services to businesses, industry insiders speculate.
Those types of companies have fallen out of favor because they either don't have a proprietary technology or because it is too difficult for them to attract the audience they need for success.
What will make a solid IPO will be a company with a proprietary technology that is highly demanded and easily protected from competition; a company with an existing customer base and steadily growing revenue base; and a company with profitability or a near-term plan to attain and sustain profitability.
Several Pittsburgh-area companies appear poised to go public within a year of the IPO window opening up.
PrintCafe, a Strip District provider of e-commerce solutions for the commercial printing industry, has had its IPO registration filed with the Securities and Exchange Commission for almost a year, ready and waiting for the right time.
CoManage, a telecommunications network software provider in Wexford, has tens of millions of dollars in venture capital and is far along in attracting a solid customer base.
And Entigo, a business-to-business partnering software company in Green Tree, received $17 million in a fourth round of funding early this year and is primed for the public market as well.
Other companies that are possibilities for the public market in the next couple of years include Cerebellum Software, eToll, TissueInformatics, eJiva and Laurel Networks.
Both Laurel Newtorks and CoManage were started by a growing list of alumni from Fore Systems/Marconi Communications who have hung their own shingle with second-generation network infrastructure companies.
A third company in that Fore/Marconi alumni group is Spinnaker Networks, which also has attracted significant venture capital.
While the spin-outs from Fore/Marconi are not new to the market this year, 2001 could be regarded as the year of the Fore Follow-Ons.
Each of these three companies has very deep pockets filled with venture capital and is engrossed in product development and early sales for products that help computer networks run better.
As this market is expected to be one of the hottest industry sectors over the next couple of years, CoManage, Laurel and Spinnaker may become household names in the Pittsburgh region within the next year or two.
In addition to network infrastructure, there are several other technologies that will garner investor attention in the coming year.
Bioinformatics -- the convergence between biotechnology and information technology -- is on the tip of many tongues.
"There will be an enormous amount of interest in bioinformatics in the near future," said Redleaf's Nelson.
"Bioinformatics will be the investment focus of the decade," speculated Sean Sebastian, a venture capitalist with Birchmere Ventures.
"The mapping of the human genome will lead to a tremendous amount of focus on bioinformatics," said Morgan Lewis' Myers.
Other areas of focus, the group of industry leaders agreed, are network security -- which is becoming an increasingly visible niche for Carnegie Mellon University and the technology community around it -- wireless and broadband services and software that builds efficiencies for businesses.
These are markets where venture capitalists anticipate spending their money in the future.
But much like the changes in the rules of IPO investments, venture capitalists are taking a different approach to their investments as well.
In the latter half of 2000, venture capitalists began to see their return on investment slow.
They still had large funds that had been raised and plenty of money to allocate to the right businesses, but they had to put the brakes on, just like everyone else.
"The slowdown of investment opportunities has forced [venture capitalists] to focus in on their existing portfolio companies and to wait for better valuations in the IPO market to ripple down to the private markets," Sebastian said.
In other words, the portfolio companies are not just magically going public and making everyone rich anymore.
The investors are having to spend more of their time cultivating and positioning the portfolio companies, which leaves less time to scout new opportunities.
"Quality business ideas will continue to get funded, but investors are spending more of their time working on the health of the companies they have already invested in," said Nelson.
Venture capital funds probably will continue to raise less money for their funds and will find it more difficult to raise funds unless they have proven track records.
But because many of them already have plenty of money to invest, experienced entrepreneurs with good business propositions should still find the money they need.
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