Southern California Investment Continues to Surge Amid Dotcom Downturn –

When content-related investments were all the rage, a number of venture capital firms established beachheads in Southern California, assuming that the Los Angeles content scene would provide a bevy of investment opportunities in the New Economy.

After the market turned on these investments, many thought that the VC firms would skulk away from the region in the dark of night, hoping not to be noticed. However, the facts turn out to be quite different as the climate there has rewarded participants with something more pleasing than a tan – an active, vibrant deal culture.

According to Venture Economics data, the region has not seen a decline in activity at all, and indeed has seen more deal flow in the first three quarters of 2000 than came over the proverbial transom in all of 1999.

Through the third quarter venture-stage companies in the Southern California region raised more than $6.5 billion. That number, somewhat shockingly, compares favorably to 1999, where for the entire calendar year 379 companies netted a total of $5.1 billion. Furthermore, VCs don’t expect the volume to drop off anytime soon.

“Southern California will attract greater dollars over time,” said Jim Breyer of Accel Partners at a press conference on third quarter disbursement figures. “There are technologies there that will fuel the next generation of broadband.”

Clearly, Accel stands in solid company in making that assessment as fund raising has also picked up in the region. Since the beginning of 1999, 37 Southern California-based funds have raised a total of $5.5 billion, and 18 of those vehicles have closed in 2000, raising no less than $2.3 billion.

“Southern California has a few more VC funds today, but there is still a relative paucity,” says Bill Elkus, general partner at Idealab! Capital Partners. “And we are proportionally larger in the region with less competition.”

However, that size advantage may not last forever. Clarity Partners, the new firm that spawned from established local player Rader Reinfrank, recently closed on a $1 billion fund. Although the firm will reportedly look to invest in later-stage and buyout transactions in addition to venture deals, a player of that size brings definite long-term credibility to the region as well as diversity.

Idealab! Capital will not rest, the firm is planning to launch its third fund in early 2001, which will follow on the $350 million ICP Fund II that closed in September 1999.

“Many said content was the only play in Southern California, but it’s never been true that the only good thing to invest in Southern California is content,” says Elkus.

Elkus cites enterprise software and broadband access as strong areas of opportunity for the fund. Other sources identified San Diego as fertile soil for investment. Long a hotbed for health-care deals, the San Diego area now offers opportunity in communications.

St. Paul Venture Capital (see Portfolio Profile p. 48) cites the region as a new source of deal flow.

“We have been probing the waters and expect to find some opportunities there. We haven’t made any investments, but we are starting to get closer and closer to putting a few deals together,” says Patrick Hopf, managing general partner of St. Paul.

Indeed, while Internet specific deals dominated the marketplace – 69 deals worth $942 million in the third quarter of 2000 – Southern California offered firms access to a wide variety of deals in the quarter, including 15 communications deals totaling $291 million; 10 semiconductor deals totaling $209 million; 19 health-care deals totaling $166 million; and 26 software and services deals totaling $143 million.

In fact, the region placed a solid fourth for the quarter behind only Northern California, New York and New England, garnering more than 7% of the $25.9 billion invested, according to data gathered by Venture Economics and the National Venture Capital Association.

However, companies and venture firms have not been spared the difficult exit environment. Whereas the first quarter of 2000 saw nine venture-backed companies enter the public markets, raising an aggregate $1.35 billion, the second and third quarters combined to send only eight companies into the public sphere, raising a total of $686.9 million.