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Menlo Park venture firm keeps up investing pace- NEA thinking long term

New Enterprise Associates is running against the herd.

At a time when some venture firms are closing their doors or slashing investments in start-ups, Menlo Park’s NEA
has barely blinked. It has poured more money into early-stage start-ups than any other venture capital firm during the
past two quarters, according to data from the MoneyTree Survey, compiled by PricewaterhouseCoopers, the National
Venture Capital Association and Venture Economics.

By Matt Marshall
Mercury News

To keep up the frenetic pace, partners have ruthlessly shed dead weight from their portfolio — presiding over round
upon round of shutdowns and layoffs. They have also thrown out conventional wisdom on which sectors to invest in,
and instead rely heavily on entrepreneurs close to the ground.

“Last year was brutal,” said Scott Sandell, the 37-year-old partner who directs strategy for the firm’s latest $2.3 billion
fund.

Time to invest

Most venture capitalists agree that now is a great time to invest. Oracle and Cisco were both founded in anemic
years, Oracle in 1977, and Cisco in 1984, and had to wait for better times before going public. Rock-bottom salaries
and real estate save start-ups money. In return for much-needed cash, entrepreneurs give venture capitalists a
greater ownership in their company. And once the market turns up in four or five years, big bucks can be made.

But few venture capitalists are backing that up with action, according to Jesse Reyes, vice president of Venture
Economics, a data research company. It “seems everyone is taking some time off,” he says.

And while some other venture firms — such as US Venture Partners and Bessemer Venture Partners — are investing
at or near their previous pace, NEA stands out for its sheer size and number of investments.

The 24-year-old firm pumped $200 million into 23 new start-ups in 2001 and continued that pace into 2002. For 10
years, NEA ranked among the top three venture firms in number of companies funded, and number of initial public
offerings.

NEA has hit those numbers partly because it raised more money from its investors, and hired more partners to
handle the load. Since 1996, NEA has doubled the number of partners to 21. But NEA also has pursued its pace with
sheer bloody-mindedness — sticking to a rate of about 1 1/2 new investments per partner, every year.

NEA’s investment bets during a downturn might sound risky, but some VCs believe they have a good chance of
pulling it off: “The NEA partners have always taken a long-term view of the venture capital business,” says Jim
Breyer, a venture capitalist at Accel Partners. “I believe that they will continue to do extremely well.”

For Sandell, who invests in software companies, last year was one of the toughest of his career: On average, each of
the 10 companies he had funded weathered 2 1/2 rounds of layoffs. He says he had trouble sleeping at night.

While it is normal for venture capitalists to have to fire a chief executive officer for under-performance, it is much
tougher to lay off rank-and-file workers, he said. CEOs usually take time to negotiate — often, up front — sweet
severance packages, he said. For regular workers, though, severance packages are small, especially at companies
that have no cash left.

“You put them on the street without financial support,” he says. “The hardest ones are where you’ve been involved in
recruiting the team and then you lay them all off. There were several examples of that.”

Early on, it was easy for workers to get jobs again. Sandell tried to help.

In late 2000, he recalls, he second-guessed the CEO of San Bruno’s Demandline, who wanted to fire 32 of his 35
workers after Christmas break so that they could enjoy the holiday. Sandell argued — and prevailed — that it would be
better to cut them before, so that they’d have the support of their families and return to the job market earlier. In the
end, all but two were able to get jobs within two months.

Those were the good days. Just nine months later, one was laid off again.

Placing trust

The downturn also meant placing more trust in entrepreneurs, and less trust in NEA’s assumptions about where to
invest. Sandell said he called two special meetings because he thought NEA’s investment pace was too quick —
especially in the overheated telecommunications sector. Gone were the days, he said, when “you could back a truck
up and invest in everything that you saw.”

Sandell voted against six telecom deals in a row proposed by his partners — an unusual move since deals are
usually agreed upon by NEA partners in consensus, without voting. Last fall, Sandell called another meeting,
insisting the pace was still too fast. “I look at my role as the bully pulpit for the fund,” he said.

Sandell also relied on entrepreneurs for direction. He recruited two so-called entrepreneurs-in-residence to spawn
new ideas for start-ups, under the watch of NEA.

The first, Nat Kausik, launched FineGround Networks, which Sandell funded in July 2000, now based in Cupertino.
The second, Kai Li, founded Data Domain, which Sandell seeded in October 2001. Likewise, NEA’s other partners
have funded the start-ups launched by seven other EIRs over the past two years.

Sandell believes the venture cycle reached its low point in November, and that a recovery is under way. The rebound
isn’t evident in the statistics, he says, because seed companies often are kept secret and not reported by venture
firms. One of the favorable signs: Start-ups are hiring more people.

Making a comeback

And some of his once-moribund firms are making a comeback. Bizfinity, of Cupertino, lost 51 of its 55 employees
during the downturn. Last month, though, the company hit its sales target for the first time, and is nearing break-even.
Sandell points to other good news for NEA:

• Only a third of the latest fund — raised in Sept. 2000, just as the market was crashing — has been invested. Much of
that investment was made at a “high price.” That is, NEA invested more money that it should have for its ownership
stakes in start-ups. But the firm still has two-thirds of the fund left to invest at lower company valuations, giving it
plenty of so-called “dry powder.”

• NEA stayed diversified. Most newer funds focused solely on information technology companies, while NEA kept
funding health-care start-ups. Now that health care and biotech are hot, that strategy has paid off, Sandell says.

• NEA’s conservative style also has won brownie points from its investors. Many venture capitalists get a cut of profits
but also charge investors upfront, usually as a percentage of fund size. And with the downturn, investors are
protesting these high fees and demanding money back.

NEA, however, works on a different pay model: Along with profits, partners charge a set amount that is not tied to fund
size — which usually works out lower.

• In each of the firm’s five funds raised since 1991, NEA has performed in the top quartile, beating 75 percent of its
competitors.

The pressure is on Sandell to hold to that record. It will be tough: Many experts say most venture firms that raised
funds in 1999 and 2000 will lose money. But Sandell says the 2000 fund he leads and NEA’s 1999 fund are both
performing in the top quartile of fund performances so far: “I think it is lucky me, actually.”

Contact Matt Marshall at [email protected] or (415) 477-2518.

http://www.bayarea.com/mld/bayarea/business/3294955.htm

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