Seattle VCs Question the Region’s Future –

Seattle’s Type A technophiles used to be kept awake by strong coffee. These days the tech drought is the culprit. The deflation of the tech boom has hit the Pacific Northwest especially hard. Alan Frazier, founder and managing partner of Seattle-based Frazier Healthcare Ventures, says that the Northwest has been burned more than other areas of the country because it had a higher percentage of Internet investments. And he puts the blame squarely on the shoulders of the venture capital community.

“At the height of the bubble, there were 35 local venture firms,” says Frazier. “That’s ridiculous. They’re all going to go away. When the havoc is wreaked, four or five good firms will remain.”

The area is already thinning out. In January alone, Mohr, Davidow Ventures (MDV) and Atlas Venture announced that they were closing their Seattle offices. Technology law firm Cooley Godward shuttered its Seattle office that same month, citing a poor economic climate. “I looked over there one day and [Cooley Godward] were just gone-they even took the fish,” says a venture capitalist, who was in the same office complex. The January closures followed the departure of Garage Technology Ventures and Watershed Capital. The status of some smaller firms, like Pacific Northwest Partners and Vault Capital is uncertain, since they didn’t respond to phone calls.

David Alhadeff, founder of technology venture fund Velocity Capital and son of Seattle retail startup legend Victor Alhadeff (founder of Egghead and Briazz), has a brutally candid assessment of the area: “New company formation has ground to a halt. We’ve gone from one meeting a day in 2000 to two or three meetings a week today.” Alhadeff adds: “There is still energy and excitement here, but people are taking time in doing deals. I wish I could be more optimistic, but there is no reason to think things will improve.”

Too Much Too Soon

Venture Capital Journal interviewed 15 venture firms with offices or headquarters in the Pacific Northwest. The consensus was best expressed by Dan Levitan, managing partner of Seattle-based Maveron’s office: “The expansion of VC was too quick. There is no infrastructure here to support that much [VC], so now it’s contracting. Still, there is a lack of skepticism here-a belief that extraordinary things can happen.”

Before extraordinary things can happen, the area will have to dig itself out of a deep hole. Last year investment in Washington state hit its lowest point since 1998, according to a Venture Economics survey. The area pulled in $599 million, down 43% from $1 billion in 2001 and down from $2.7 billion in both 2000 and 1999. While the state’s decline is in line with the overall VC investment downturn across the United States, the trend showed signs of worsening in the fourth quarter. During that period, 25 Washington companies raised $90.1 million (for an average of $3.6 million each), the smallest total since the fourth quarter of 1997.

There may be no better barometer for the region than OVP Venture Partners, the oldest VC in the area. Founded in 1983 by Rainer Bank and Hambrecht & Quist, OVP has made only two investments in the eight months since it raised its raised its sixth fund in June 2002. “Seattle attracted lots of drive-by investors [during the boom],” says Partner Chad Waite. “Their portfolios are a train wreck. I’ll wager over half of the VC firms here at the peak won’t raise another fund.”

Don’t even mention fund-raising to Don Elmer, managing general partner of Pacific Horizon Ventures (PHV), an early-stage VC. He says there is no shortage of good deals but “we have no money.” Elmer is trying to raise a fourth fund for the seven year-old life sciences venture firm, but he is finding little interest. “The Northwest is at an economic crossroads,” he says. “Boeing, the wireless industry, and instrument manufacturers-long-term anchors of the region-are gone,” and the state’s government is doing little to provide leadership during the economic downturn.”

Unfriendly Skies

Waite says the loss of 75,000 to 125,000 jobs at Boeing cannot be underestimated. He points to several other problems that have made the area less attractive to investors: infrastructure problems in transportation and roads in metropolitan Seattle, a smaller gap between the cost of living in Seattle and the cost of living in the San Francisco Bay Area, and just a single academic center: the University of Washington.

Despite the problems facing the Pacific Northwest, the people who call the region home remain optimistic that things will improve. Waite, for one, sees a silver lining in Microsoft, which has 35,000 local employees. The software giant offsets the loss of Boeing to some degree, at least for the venture capital community, because Microsoft acts as a technology incubator, he says. “Almost every deal we invest in has Microsoft heritage,” he says. Indeed, almost every venture firm VCJ spoke with for this story has some link to Microsoft.

Even the jaded Frazier sees underlying strength in his adopted home, specifically in four key sectors: life sciences, wireless, retail, and enterprise software (because of Microsoft’s presence).

PHV’s Elmer says that “biotech is as good a candidate as any other for next driver of our economy.” In fact, investments in life sciences companies last year surpassed software deals for the first time in six years, according to the Venture Economics. The sector pulled in $166 million in 2002, eclipsing the $152 million that went into software developers and $91 million that went into telecommunications companies.

Let Loose the Bulls

Others are bullish about retail. Maveron’s Levitan, the banker who took Starbucks public, and Howard Schultz, the man who turned Peet’s Coffee & Tea into a national chain, say they are investing in several promising classic consumer retail companies, as well as Internet-based services that support retail.

Almost every investor VCJ spoke with said he or she continues to remain bullish about wireless, whether it’s infrastructure, services or software.

Despite the departure of several venture firms and Cooley Godward, others say they have no intention of pulling up stakes, like Venture Law Group (VLG), the first Bay Area firm to expand to the Northwest region in 1996. “There is more money flowing now-not what you might call a healthy pace, but more than a year ago,” says Sonya Erickson, director of VLG’s Seattle office.

Tech law firm Wilson Sonsini Goodrich & Rosati, which has laid off staff in the past year, also says it will keep its office in Kirkland, Wash. “Despite the fact that the Northwest has been harder hit by the tech recession than [Silicon Valley],” Wilson Sonsini still gets regular calls from Silicon Valley VCs who want to invest in the region, says Patrick Schultheis, a managing partner based in the Kirkland office.

Maybe the best idea is to follow the road less traveled, like Northwest Venture Associates (NWVA). Tom Simpson, managing partner of the Spokane-based firm, says he did three deals in 2002 and will do three to five this year. Notably, NWVA invests in some companies that most venture capitalists wouldn’t. For example, it has put money into Pet’s Choice, a chain of veterinary clinics, Sur La Table, maker of high-end cooking utensils, and Front Porch Classics, maker of nostalgic children’s games.

No Deal Shortage

Simpson remains jaundiced by what happened on the other side of the mountain range during the dot-com boom. “I never got the New Economy thing,” he says. He admits to making two or three mistakes in his third fund, but says that’s nothing compared to Seattle VCs. These days Simpson says he still sees lots of good opportunities: “Deal flow has dramatically increased in the last 12 to 18 months.”

Bill McAleer, managing director of Voyager Capital, another large Seattle VC firm, suggests that the Pacific Northwest always suffers greater extremes than Silicon Valley, because the region is not as mature. “The good news [for the region] is the continued growth of Microsoft, which means that unlike Austin or the Bay area, IT has fared better as an area of opportunity for venture,” McAleer says. “The bad news is that the washout from three waves of Internet: B2C, B2B, and wireless investing continues.”

Like NWVA’s Simpson, he says that deal flow has picked up in Seattle in the last three months. Moreover, remarkable entrepreneurs like Bill Gates, Paul Brainerd and Jeff Bezos, are the real strength of the region, and they continue to support and believe in the region, he points out.

Chuck Hirsch, managing director of Madrona Venture Group, the first outside investor in, subscribes to this more touchy-feely outlook on the Northwest. “There is something in the water here,” he says. “The people who gravitated here from across the country are a remarkable group and that has not changed.” Hirsch says the region demonstrates a multi-generational cycle. Microsoft gives birth to Real Networks that gives birth to Isilon (a Madrona portfolio company). “Sure, the Northwest is challenged right now, just like all of the other regions of the country,” Hirsch adds. “But the region has strengths in Battelle, Pacific Northwest National Laboratory, the University of Washington, the Hutchinson Cancer Research Center and Microsoft [and] sectors like wireless, biotech, informatics and IT.”

“Seattle is making an early recovery from the scorched earth of the dot-bomb era,” observes Tom Huseby, founding partner of SeaPoint Ventures. “There is still over-funding of startups in Silicon Valley, but that era is over in the Northwest, leaving an atmosphere of realism that will create a new generation of great startups here.”

As to when technology investing will return to an upswing in the Seattle and its surrounding region, there is a consensus that business is already better than last year. There is a sense that the region has “hit bottom,” Frazier says, but there is also the recognition that the Northwest as a region follows both Boston and the Bay Area in terms of a full recovery. And no one is predicting that in the upcoming year.