Who Says the Startup Is Dead?

Young companies with a hot technology and a promising customer base still drive VCs
wild. You could hear a lot more from these seven startups before they’re through.

By: Scott Herhold Business 2.0

When Mark McDade went looking for more money for his startup early last year, he was brimming with confidence.
His firm, Signature Bioscience, had developed a way of testing drugs using microwaves, and to him, the company’s
potential was obvious. His offer: Give us about $40 million in working capital, and you’ll own a quarter of the company.
No one rushed to write the check. "People said, ‘We like the story, we like the technology, but if you think your
company’s worth that much before we put anything in, you’re out of your minds,’" recalls McDade, a personable
Harvard Business School graduate. So the Signature people did some soul-searching and returned with more
modest demands: For roughly the same price, you’ll control more than a third of the company. The concession was
"gut-wrenching," McDade says, but it worked. Last July, Signature raised $43 million — cash that’s now allowing the
company to bulk up through acquisitions. And Signature enjoyed this rare coda: It was still valued more highly than at
its previous round of funding.

Such is the entrepreneur’s road to riches following the technology collapse. The way is narrower, less certain, more
bruising (to bank accounts and egos alike), and, above all, far slower than it seemed 24 months ago. Hard as it is for
a fledgling company to kindle venture capitalists’ enthusiasm these days, it’s harder still to maintain it. One indication:
Some Silicon Valley VCs estimate that as many as 80 percent of all financings in 2001 were down rounds, meaning
that the VCs had slashed their estimate of a company’s value since its previous funding round.

Even in this brutal venture capital drought, however, some companies still get VCs excited. Startups with the right mix
of marketable technology, realistic business plan, and credible management are actually rising in value when they go
back to investors. These days, that is a young company’s ultimate endorsement. We’ve identified seven firms that
meet that rigorous standard. They come from different niches — biotech, consumer, and business technology
products — but they all share traits that VCs say are indispensable to success.

Most important, each firm boasts a tenable, marketable, and defensible technology, often protected by patents.
"Venture firms want to invest in something that won’t take a group of kids six months in a garage to replicate," says
Mark Saul, a VC with Foundation Capital in Menlo Park, Calif.

Next, VCs generally want assurance that a company will have customers and that those customers will eventually
generate revenue. In this postbubble world, a business plan that proposes to seize some undefined market is dead
on arrival. Instead, VCs want to know precisely who the intended customers are. With the arguable exception of the
two biotech firms, the companies we’ve identified have pragmatic, well-defined ambitions. Humility is in; hubris is out.

Finally, all of these companies have submitted their leadership and their balance sheets to a vetting process that
could have uncovered minute flaws in the Hope Diamond. With money tight, a veteran team with a conserve-the-buck
approach counts as a serious advantage. "I’m looking for people who know how to spend money wisely," says Mike
Orsak, a venture capitalist with Worldview Technology Partners in Palo Alto. And since the public markets have little
appetite nowadays for unproven startups, these companies aren’t talking about IPOs. For now, they’re focused on
becoming profitable.

Here, then, is our list. While none are surefire successes, all have earned higher valuations in one of the toughest
times in memory.

Beyond Wi-Fi

Atheros
Founded: May 1998
Product: Wireless networking chips
Last funding: $66.7 million

Seen people surfing the Internet wirelessly while waiting for their plane or latte? They’re tapping into a network that
uses a standard known as 802.11b, sometimes called Wi-Fi, and it’s one of the few very hot areas in venture
investing. (For more on Wi-Fi, read "The Island of the Wireless Guerrillas".) The persistent buzz, though, is about a
company that’s trying to develop the next generation of wireless networking, called 802.11a, which delivers the data
much faster over the same distance.

Atheros has a curious pedigree: Its godfather and chairman of the board is Stanford president John Hennessy, who
worked early with Stanford graduate student Teresa Meng to develop what they called a "radio on a chip." A lot of
companies they approached thought the idea was too far-out. So Hennessy and Meng decided four years ago to form
their own company.

"This company is so much not a product of the times in which it was financed," says August Capital partner Andy
Rappaport, who sits on the board. "When they were making the rounds of Sand Hill Road in mid-’98, they had this
brilliant technology, and all the venture people they talked to said, ‘Hey, how can you get a product out in nine
months?’ This team said, ‘Forget it, we’re not gonna do that. We want to be dark for 18 months and press the limits of
our technology.’" That stance paid off: Buoyed by positive reviews of its technology, Atheros is still working on a $66.7
million round it raised in April 2001 from a group of investors led by Fidelity.

The Web on Your Hip

Danger
Founded: January 2000
Product: Mobile device
Last funding: $36 million

If nothing else, this Palo Alto wireless company can easily claim to have the catchiest moniker of our group. But what
caught the VCs’ eyes about this startup was its potential to become a "BlackBerry killer" — a company whose product
could supplant the popular handheld that lets corporate officers get their e-mail on the road. Danger’s wireless
device, as planned now, will include a thumb-only keyboard that lets a user get e-mail, a calendar program, telephone
numbers, and full Internet pages, not the stripped-down variety available with other products.

Danger’s CEO is Andy Rubin, formerly an executive with WebTV, who says he started the company when he couldn’t
find a good chess program for his Palm Pilot. Rubin says the real value of Danger’s Hiptop device lies not in the
hardware — which could eventually be built by someone else — but in the software that runs the server sending out the
signals. The Hiptop is a bit heavier and bulkier than a Palm Pilot, but Rubin believes it’s well within the range that a
broad audience will tolerate. (As he points out in a comparison that is only slightly tongue-in-cheek, the Hiptop is still
smaller than the handhelds on Star Trek.) "Techies want something that’s paper-thin," he says. "But I’m not sure the
mass market sees it that way."

Biotech Plumbing

Fluidigm
Founded: December 1999
Product: Drug discovery
Last funding: $34 million

Like some famous public companies (Apple, Hewlett-Packard, Microsoft), Fluidigm was born partly of a buddy act:
Gajus Worthington and Stephen Quake were good friends in the early ’90s at Stanford, where they studied physics.
After they graduated, Worthington joined a Silicon Valley company and Quake became a professor at Caltech. Then, in
1999, they joined with another friend, consultant Todd Krueger, to form Fluidigm, a San Francisco-area firm involved
in one of the most ambitious fields of biotech: microfluidics. The early Stanford bonds have helped to mold much of
the company’s culture. And what seemed anachronistic in the go-go days of the late ’90s — the company’s devotion to
hard-core technology — is suddenly very much in vogue among both investors and employees. "We don’t subscribe to
fads," Worthington says.

Biotech research has always been hampered by the mismatch between traditional laboratory equipment and the
microscopic materials being tested — cells, even molecules. Fluidigm’s technology promises to scale down the
equipment and automate the research process, essentially creating a laboratory on a chip. That makes it possible to
conduct many tests at once. Worthington uses this analogy: When the integrated circuit was first built, scientists had
to reduce bulky vacuum tubes and transistors to miniature engravings on silicon. Fluidigm, which has perfected a
pump-and-valve technology for tiny amounts of fluid, aims to do the same for biotech. It’s safe to say that venture
capitalists are wild about this notion. In November, after the company went out to raise $25 million, it wound up
getting $34 million from a group led by Lehman Bros.

The Portable Network

Neoteris
Founded: May 2000
Product: Secure and cheap network access
Last funding: $15 million

When Neoteris got $5 million in first-round funding last April, it sought to keep the news under wraps. The Mountain
View, Calif., startup, which produces an appliance that lets traveling workers connect easily to the innards of the home
fort using just a browser and a password, found its biggest investor in Netscape co-founder Jim Clark, the godfather
of at least half a dozen Silicon Valley companies. Clark’s star has been partly eclipsed by disappointments with
Healtheon/Web MD and the folding of the Kibu site for teens, which he backed. Even so, the Clark connection has
attracted far more attention to Neoteris than the typical startup receives.

Neoteris’s CEO, Kittu Kolluri, handled the firm’s semi-celebrity status by delaying the announcement of its first-round
funding and holding off on unveiling the company’s product for six months. "I’m averse to hype," he says. So when
Neoteris surfaced publicly in November, it boasted something real: an appliance that attaches to a company’s
network and guarantees employees secure and cheap access to their e-mail, calendar, and corporate documents
from afar. Even though Neoteris suffered a setback when one of its investors, the Barksdale Group, broke up in
January, other investors banged on its door. Early this year, Neoteris announced a $15 million round of funding led by
New Enterprise Associates, a favored firm of — yes — Jim Clark.

Free the Data

Peribit
Founded: May 2000
Product: Network traffic trimmer
Last funding: $20.5 million

When this networking company closed a $20.5 million round led by the Mayfield Fund early in March 2002, it had
tripled its valuation in little more than a year. The company was so confident that it set a three-week limit for venture
capitalists to submit their term sheets. It received six of them. And then it picked the lowest offer — partly because CEO
Jef Graham felt Mayfield would provide the best advice.

Peribit, based in Santa Clara, Calif., had its genesis in the work of Amit Singh, a computer veteran who had done
research on matching DNA sequences while a Ph.D. candidate at Stanford. Singh thought his research could be
applied to data networking. So Peribit has devised a box that can recognize repetitive data sent over corporate wires —
a graphics-intense logo, say, or the header on an e-mail. By storing a code that can plug in that information without
another transmission, the technology can save a corporation valuable networking resources. Graham, a former
3Com exec, estimates that the latest round, which brings the company’s total funding to slightly more than $30
million, will take the 33-person startup into the black. "Profitability," he says, without a hint of irony, "is very important."

Drug Research by Radar

Signature Bioscience
Founded: October 1998
Product: Drug evaluation systems
Last funding: $43 million

As the dotcoms move out of San Francisco’s South of Market district, Signature is moving in, taking over a
65,000-square-foot office vacated by a failed company. Although CEO Mark McDade encourages his more than 135
employees to bring in children’s illustrations to decorate the lobby, nothing’s childish about the company’s technology
for discovering new drugs.

In a kind of biotech police radar, using microwave transmitters not unlike the ones that carry your cell-phone calls,
Signature’s system bounces a signal off a protein or cell in the presence of certain compounds — and then measures
the results. The developers of drugs are attracted to this method because it provides a potentially quicker and more
accurate way of testing medical remedies — without injecting the cells with the dye commonly used in such
experiments.

Signature has been around since late 1998. But the $43 million in funding led by SG Capital Partners in New York
has let the company make three acquisitions that McDade says will extend its reach into such areas as cancer
research. One reason the deals work is those pictures on the walls. "I tell people that family comes first," McDade
says. "And if you’re not having fun, it’s not worth doing."

A Tiny Giant in Storage

3ParData
Founded: May 1999
Product: Servers
Last funding: $100 million

If there’s an article of faith among venture capitalists today, it’s that the market for storage — the technology that holds
and retrieves a corporation’s data — will continue to grow by leaps and bounds. Few companies in that arena have
generated more buzz than 3ParData, a company in Fremont, Calif., that is building a new generation of servers called
"utility storage," essentially a way of centralizing how a business stores its data. Last summer 3ParData closed a
staggering $100 million round that was led by Amerindo Investment Advisors. In fact, CEO David Scott says interest
was so intense that the company actually had to pare down the money some investors wanted to put in. A big reason
for the excitement was that 3ParData was founded by four engineers from Sun Microsystems, who brought 25 of their
colleagues. With endorsements from Veritas and Sun, the company is taking direct aim at EMC and Hitachi, two of the
leaders in the storage market. One mark of its strength is that it gave away no board seats in its latest round, keeping
more control in the hands of the entrepreneurs.

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