Most Investors Were a Mirage In 2002 –

It sounded like an overstatement, but the oft-heard complaint by entrepreneurs that they couldn’t raise money in 2002 wasn’t too far from the truth. The last time venture capitalists invested so few dollars was about five years ago.

Venture firms did about 2,700 deals worth about $21.2 billion in 2002, the lowest totals since 1996 and 1997, respectively, according to the PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree Survey. The number of deals declined 44% from 2001 and the dollar amount was off by 52%. Industry watchers expect the dry spell to continue this year.

But into each parched entrepreneur’s life some rain must fall. In this case, the rain came principally from venture firms that deliberately increased their deal making to take advantage of bargain-basement valuations while their peers clutched their wallets. The three biggest rainmakers in 2002 were Intel Capital, New Enterprise Associates (NEA) and Venrock Associates (see chart). All three say they plan to be every bit as active in 2003.

Anti-Corporate

Intel is a rarity not just in venture capital investing but also in corporate venture capital in particular. While most companies are mothballing or shutting down their venture efforts, Intel is talking about ramping up.

John Miner, general manager of Intel Capital, says that to a large degree his group’s future funding activity depends on the venture capital industry as a whole, but that Intel will be more active in 2003 and put deals together if traditional VCs don’t step up to the plate. “We’re prepared to step in and lead in the early stage to form a syndicate and get companies funded early on,” he says. “We’re ready to kick-start things and be more proactive than we have in the past.”

An Intel spokeswoman says that company plans to invest as much this year as it did last year-about $200 million on 100 portfolio companies. Two-thirds of last year’s deals were follow-on investments, while the remainder was new. This year Intel expects to spend the bulk of its investment dollars on new portfolio companies, the spokeswoman says.

The company won’t say exactly where its new dollars will go or reveal the key sectors in which it has invested in the past. Anecdotally speaking, it is interested in wireless infrastructure and devices, sensors, MEMs, nanotechnology, semiconductor suppliers, fuel cells and Internet services, among other things.

Among the largest deals that Intel participated in last year were Chiaro Networks, an Internet protocol infrastructure company based in Richardson, Texas, that raised $80 million in its fourth round; Campbell, Calif.-based multimedia software provider Syndeo, which raised a third round of $75 million; and SmartPipes, a Redwood City, Calif.-based Web software developer that raised $51 million in its fourth round.

On the wireless front, Intel announced in the fourth quarter that it would commit $150 million toward Wi-Fi, the technical standard for wireless local area networks. Since then it has made 10 Wi-Fi investments. “And we have a lot more to go,” says Miner. “I think that the Wi-Fi area is probably going to get a lot of attention and have a lot more visibility. We have a lot of product launches related to Wi-Fi. This activity is motivated by our desire to make mobile computing an anytime, anywhere event.” (For more on Intel’s outlook on Wi-Fi, see the column by Intel Capital President Les Vadasz on page 43.)

Intel, which saw 40% of its deals go to overseas companies in 02, is ramping up its participation in Russian deals and plans on increasing its number of investments and starts in Asia. Its U.S. regional demographics will follow the U.S. VC industry as a whole.

It should be noted that Intel Capital’s bullish plans could be adversely affected if its parent corporation gets impatient after two years of bad news. Intel Capital wrote down $372 million off the value of its $1.1 billion investment portfolio last year, following a $469 million write-down in 2001, according to Intel Corp.’s fiscal 2002 earnings statement, which was released in January.

Just As Predicted

Like Intel, NEA did 100 deals in 2002, but it put a lot more capital to work-a total of $490 million. The surge in investing reflected a plan that firm co-founder and General Partner Dick Kramlich laid out in late 2001. “We hope to be able to look back at this time and say it was one of the best in 20 years,” he said in an interview then. He went on to explain that NEA historically has invested aggressively during down markets.

Managing General Partner Peter Barris says NEA will keep up its fast pace this year. “The truth of the matter is, I don’t see a lot of difference in our modus operandi going into 2003,” he says. “We’ve been traditionally early stage in information technology and health care. What’s happened in the last 12 to 18 months is that we’ve had a fairly material shift between sectors. In bubble periods we’re 85/15 in favor of IT. Now we’re at our traditional 50/50 level.”

NEA may do more deals in IT, but its health care deals consume more capital. This is likely to remain the case this year. It will still keep its health care focus 2 to 1 in favor of biopharmaceuticals and drug discovery deals over medical devices. The firm re-emphasized its health care practice in 2001, with the goal of increasing its life sciences deals from 15% to 30% of its total. It brought aboard biotech entrepreneur James Barrett in August 2001, naming him a general partner to lead its rekindled interest in the sector.

One slight change is that the firm expects to move toward earlier stage health care companies. In addition, NEA expects to do more deals related to service and specialty pharmaceuticals. “Now we’ve done some service deals and some of what we call specialty pharmaceuticals, but what you might call roll-ups” says Barris. “The deals involve licensing drugs in specialized areas of medicine and consolidating their marketing and distribution under one roof.

On the IT side, Barris sees NEA moving away from its strong emphasis on security and storage-related deals last year. “Looking at 2002, close to half of our dollars were in security or storage related deals,” he says. “I think those are pretty over invested areas right now. I would not expect that would be our focus going into 2003.”

What’s more promising to NEA is software infrastructure and applications deals and the wireless segment, despite a marked increase in Wi-Fi deals over the past year. “I think software infrastructure generally will be a strong area of investment for us,” he says. “We’re returning to enterprise software, part in the infrastructure side and to a lesser extent on the applications side.” As for wireless, Barris says Wi-Fi “has a lot of promise.”

NEA’s big 2002 deals included San Jose-based optical component maker Caspian Networks, which raised $120 million in its fifth round; Alpharetta, Georgia-based biotech outfit Inhibitex, which raised a $45.4 million fifth round; and Palo Alto, Calif.-based specialty drug maker Alexza Molecular Delivery, which raised $45 million in its first institutional round of funding.

Barris says the firm has been involved in some recent deals and found the environment to be very good. “What I found promising was the behavior of all the constituents,” he says. “The entrepreneurs were not so concerned with the highest price as they were interested in getting the best VC that could help them. The VCs were competitive but not ratcheting up the price. There was a lot of good behavior going on and I think it was a very good sign, in contrast to what we went through in the 1999 to 2000 cycle.”

Venrock Gathers No Moss

Venrock was the third most active investor last year. Managing Partner Tony Sun expects the pace to continue. “We are always looking at our investment strategy and if it’s still relevant,” he says. “At this time, I think steady as it goes’ is the right mantra.”

Venrock invested $162 million in 53 companies in 2002. Venrock may not have been at the top of the most active list in years past, but Sun says that it is the firm’s consistency that made it stand out in 2002. “We maintained our active position in that we invested through good times and bad,” he says. “We did not accelerate or go crazy during the boom times and we did not freeze up and hibernate during the down cycle.”

That doesn’t mean its investment strategy hasn’t changed at all. “Throughout 2001 and 2002 we were rotating our sectors of focus very rapidly,” Sun says. “We are now moving into new areas where we see great opportunities for returns.” To that end, Venrock plans to increase its investments in health care this year. “In good times and bad, health care will be between 25% and 45% of our practice,” Sun says. The firm has had a strong focus on drug discovery. It is now venturing into selective medical device areas.”

Among Venrock’s largest 2002 deals were the $70 million second round of Boston-based drug discovery company Infinity Pharmaceuticals, the $54.9 million second round of San Jose, Calif.-based switch maker Polaris Networks, and the $43.9 million fourth round of Santa Clara, Calif.-based biotech firm XenoPort.