The early bird with the research software catches the billion-dollar worm. At least that’s the way it works in Silicon Valley.
And, of all places, at venerable Menlo Ventures. You’d think the firm, founded 25 years ago, would be a little stodgy. But it’s anything but. Tom Bredt, who joined the firm in 1986, epitomizes Menlo. At the age of 61, he’s had a lengthy career in industry (Bell Labs and Hewlett Packard), academia (Stanford) and venture capital, and yet he’s still eagerly looking for the next big thing.
Bredt says the key to Menlo’s success is that it doesn’t follow other firms’ investment strategies. Yes, lots of firms say that, but they just say it because it sounds good. Menlo has the track record to back up its claims, with a list of hits too long to mention, including Ascend, Bay Networks, Gilead Sciences, Infoseek, Kalpana, LSI Logic, and UUNet Technologies. The firm set out to raise $1 billion last year, but demand drove it up to $1.5 billion.
Part of Menlo’s success is due to a systematic internal research program that Bredt and his partners developed over the past 15 years. The system generates about half their deals. Bredt won’t say exactly how it works, for obvious reasons. But it works. And how!
“We pick roughly 10 emerging markets a market large enough to support at least one successful IPO of a venture-backed or a growth company and then our strategy is to find and invest in the best company in that emerging market,” he says. “We want to be in the best company independent of geography and independent of stage of development.”
Once a company or promising idea shows up in the press, it’s too late, Bredt says. By that time, five venture-backed companies will have crowded the space and Menlo will be forced to come in on a later round.
All things being equal, Bredt prefers to invest early, and with such a big bankroll to play with, he doesn’t mind taking an entire round himself. Hey, what’s a gigafund for?
One of Bredt’s first successes from “the system” was Clarify Inc. He invested in 1992 and the company went public in 1995. (It was later acquired by Amdocs.) The system also pointed him to Siebel Systems Inc., but, try as he might, he couldn’t convince Tom Siebel to take venture money. No matter, he’d make it up on the next one.
Bredt’s other guiding investment principal is to back companies that provide solutions, not just interesting or cutting edge technology. This concept is beyond a cliche, but Bredt and Menlo have been focusing on customer “pain” for years. “Part of that process is to be knowledgeable about what is keeping the executive staffs of major corporations awake at night,” he says. “What are the top three or four problems they are dealing with?”
Following the firm’s tried-and-true system of identifying a need and then finding a company to fill it, Bredt became the early bird that caught the billion-dollar worm.
After identifying optical switching as an emerging market, he met the founders of Xros (pronounced Ky-Rohs) through a former colleague at Stanford University, where Bredt taught computer science for seven years.
“At the time we invested [in 1999], they had an inventor, a president of the company and about six engineers, and they were working in a small office in Mountain View, California,” he says. “They had a unique approach to build an all-optical cross-connect switch based on this technology called MEMS [MicroElectroMechanical Systems].”
Bredt knew he was on to something big, so he had Menlo provide all of the backing for the first two of three venture rounds. After 14 months, he convinced the company to sell out to Nortel Networks Ltd. for $3.25 billion in June 2000. Menlo, which owned one-third of the company, made more than $1 billion.
“We’ve been told by Credit Suisse First Boston, who represented Xros in the acquisition, that on a risk-adjusted basis, it was the highest price ever paid for a venture-backed company,” Bredt says cooly, just as he might talk about any other investment. “We were 14 months into the company, and while we had prototypes we could demonstrate, we did not have a working product. And, we did not have customers. If you look back at the last 15 or 20 years of venture capital, deals like that are rather unusual.”
How do you follow a hit like Xros? You don’t. But that doesn’t stop Bredt from pursuing other not-so-big hits. He is driven by the thrill of the hunt.
Among the startups he found through the Menlo research system is Apexon, which makes software that automates supply-chain communication between manufacturing companies and their suppliers. Sure, it sounds boring. But so did Xros.
Investment Focus: Communications and enterprise software
Biggest Hits: Aspect Communications (NASDAQ: ASPT), Clarify (bought by Nortel), Latitude Communications (NASDAQ: LATD), Red Brick (bought by Informix), and Xros (bought by Nortel).
Board Seats:Apexon, Caw Networks, Cielo Communications, ePeople, Nuasis and Teradiant Networks (7 total)
Years as a VC: 15
Did you know? Bredt was a computer science professor at Stanford University.
Reporting by Charles R. Fellers.