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Regional VC: Northwest

Venture capitalists may not be supporting the number of startups they once did, but make no
mistake: Venture capital is alive and well.

by Patty Enrado – Upside Today

Upside visited the Northwest, Northeast, and Southeast for
this year’s regional venture capital special report. As expected, similarities exist across the United
States, including the sentiment that startups are out of luck as VCs continue to focus on their
portfolio companies. What’s the one underlying theme for garnering venture capital regionally or
nationally? You guessed it: revenue. If you don’t have any, start packing. No one is going to give you
money.

Of course, this is not a revelation. So this year, Upside looked within each region, beyond the
rhetoric, to find out what industries still interest VCs. With biotech, security, storage, and Web
services leading the way, VCs are cautiously spreading their risk across numerous industries and
hoping for the best.

Vast forests, fertile land, and a rugged coastline—the Pacific Northwest abounds with natural
resources, and, appropriately, logging, agriculture, and shipping once drove its economy.

But the region slowly evolved into a technology hub as companies began putting down roots. Testing,
measuring, and monitoring firm Tektronix was founded in 1946, putting the Beaverton/Portland, Ore.,
area on the map in the semiconductor and computing industries. In 1976, Intel opened its first
Oregon campus in Hillsboro, and it is now the state’s largest private-sector employer with
approximately 15,000 employees. Bill Gates founded Redmond, Wash.–based Microsoft in 1977, and
biotech emerged in Seattle with the founding of biopharmaceutical firm Immunex in 1981.

Today, the Pacific Northwest is a highly regarded high-tech region teeming with entrepreneurs. The
industry has matured: Alumni from the pioneering high-tech companies founded their first startups a
number of years ago and are now blazing forward with their second and even third companies, and
established venture capitalists are eager to fund many of these early-stage businesses.

Seattle: “U-Dub,” McCaw, and Microsoft

With the presence of the University of Washington, Seattle, and other research centers; Craig
McCaw and his telecommunications companies; and Microsoft, it’s no surprise that the biggest
clusters of startups are in biotech, wireless, and enterprise software. According to the National
Venture Capital Association (NVCA), venture capitalists invested $62 million in seven biotech deals in
the state of Washington in 2001. The combined sectors of telecommunications and networking and
equipment drew $369 million across 30 deals, and software companies raised $257 million in 36
deals—the greatest total dollar amount and number of deals in any one industry. Those three areas
accounted for more than 60 percent of venture capital deals and 78 percent of money raised in 2001.

A wealth of technical expertise is within easy reach of Seattle’s biotech community. The Fred
Hutchinson Cancer Research Center, which develops and advances biomedical technology to
eradicate cancer and other diseases, boasts two Nobel laureates. The University of Washington is
the country’s second most highly funded university for medical research, behind Harvard University,
and its faculty includes five Nobelists.

Craig McCaw, wireless pioneer and telecommunications leader, built McCaw Cellular
Communications into the largest U.S. provider of wireless communication services before it merged
with AT&T and became AT&T Wireless. He also founded Nextlink Communications (now XO
Communications) and, with Bill Gates, formed Teledesic, a broadband communication provider.
McCaw is chairman and co-CEO of Teledesic.

Finally, Microsoft’s impact on the area cannot be overestimated. Enrique Godreau, managing director
of Voyager Capital, says that being in “Microsoft’s backyard” affords his VC firm access to “some of
the best minds in computer technology, in the software arena, and in IT, in user interfaces and
networking.” When you have bright people with equally bright ideas, entrepreneurship is ripe.

Enterprise Software: Getting Ideas to Market

What do you do when your successful joint venture project at Microsoft is sold before you’ve tapped
into the market? If you’re Bassam Saliba, you become an entrepreneur. Saliba teamed up with
Naseem Tuffaha, who was working on a Web-services initiative for Microsoft when he realized that he
could make a bigger impact in the financial-services sector as a startup. They founded
Fidesic—where Tuffaha is CEO and Saliba is CTO—to provide Web-services payment software,
which is integrated with other financial applications, to the underserved small- and midsize-business
market.

A huge market opportunity also led CEO Udai Shekawat to co-found AskMe, which developed a
software platform that helps large companies create and manage employee-knowledge networks for
knowledge sharing. According to market consulting firm Frost & Sullivan, revenues for vendors in the
knowledge-management space are projected to rise from $123 million in 2000 to $1.6 billion by 2007.
Shekawat knows the need is out there; AskMe’s main competitors are actually large companies that
are building knowledge-management applications in-house because off-the-shelf solutions don’t exist.

As a repeat entrepreneur and chairman and CEO of Returns Online, Shannon Hauser knows that the
market for his returns-management technology exists. His previous company successfully
standardized returns for major companies in the pharmaceutical industry. Hauser sold it and founded
Returns Online, which applies returns-management technology to consumer electronics, consumer
durables, industrial products, and product recalls. Returns Online also sells valuable returns data to
manufacturers. Focusing on these verticals makes good business sense. According to the Center for
Logistics Management at the University of Nevada, Reno, more than 100 million parcel packages a
year are returned across all retail operations, costing more than $150 billion. The center estimates
that a total of 615 million packages will be returned to retailers by 2004.

The market for multichannel-retail direct marketing is worth approximately $150 billion. That number
isn’t lost on Kevin Klustner, president and CEO of Sightward. His company uses advanced statistical
pattern recognition to predict customer behavior and recommend business actions for multichannel
retailers and other verticals. Sightward’s strength is in its statistical-analysis roots. Founder and CTO
Rod Cook earned his Ph.D. in statistical pattern recognition from the University of Washington, which
Chris Brookfield, general partner at Northwest Venture Associates (NWVA), points out is one of the
top four institutional specialists in Bayesian statistical theory. Brookfield says, “That’s a pretty good
example of core intellectual property coming out of the University of Washington and being
commercialized.”

Biotech: Seattle’s Rich Research Centers

The University of Washington is most notably beneficial to the biotech community. Award-winning
researchers and a wealth of technical expertise have helped the industry mature in the Seattle area.
Patrick Heron, a partner at Frazier & Company’s Frazier Healthcare, says his VC firm has benefited
from Seattle’s large pool of repeat entrepreneurs who have navigated through the challenges of a
startup before. The firm also collaborates with the university to help launch technology commercially.

Unmet need drives Frazier & Company’s search to fund biotech startups. Heron says, “We like to get
involved in seed- and Series A–level funding. We recruit the management team. We spend a lot of
time identifying a clear need for pharmaceutical companies, which are the drivers in the market. If it
doesn’t exist, we found it.”

This was the scenario for two startups that Frazier & Company helped found with seasoned CEOs.
Calypso Medical Technologies targets radiation therapy and oncology treatment. Skeletek focuses
on preclinical biology in the central nervous system and therapeutic area and was founded to help
biotech and pharmaceutical companies determine the safety and efficacy of therapeutics. While the
companies in Frazier & Company’s portfolio are diverse, they share the same goal of meeting the
biotech industry’s needs.

Wireless: Eliminating the Problems

The wireless sector is hot these days, but the industry is plagued with a myriad of problems that are
begging to be solved. NWVA Managing Partner Tom Simpson says that his firm focuses on
seasoned, successful executives targeting large markets with highly differentiated ideas. To be sure,
there is no dearth of startups with this combination.

Craig Eisler, president and CEO of Action Engine, points out the inability to run applications across
all wireless devices because PDAs, pagers, and other devices use different operating systems. His
company built a software platform to access data across any operating system on next-generation
wireless devices.

NetMotion Wireless’ software provides persistent, secure, and reliable wireless data network
connections—something every wireless-device user can appreciate. CEO Steve Cullen says, “We
offer Internet roaming, the ability to roam between networks. The common thread among all those
things is making mobility truly mobile while staying connected with your data.”

Raju Gulabani, CEO and chairman of TeleSym, built his company based on the potential for wireless
IP telephony. TeleSym’s software lets users make and receive phone calls with nearly CD-quality
sound over the Internet, LANs, PDAs, cell phones, and landline phones. “We’re trying to create the
technology that enables the market for IP telephony. The current technology has not really worked,
but we solved the hard problems to enable the market,” Gulabani says. TeleSym’s introduction of its
product in February illustrates “pushing the edge of what you can do in [your] respective segment,”
an idea expressed by NWVA’s Brookfield.

Whereas Seattle is well-delineated in terms of clusters of expertise, the Portland area is decidedly
eclectic. According to the NVCA, Oregon’s software sector raised $57 million for eight deals, IT
services raised $28 million over six deals, and telecommunications and networking and equipment
raised $60 million for seven deals. The remaining 20 venture capital deals are scattered across all
other sectors.

Many Oregonian entrepreneurs have come out of established companies such as Intel, Tektronix,
and electronic design automation firm Mentor Graphics, but Gerard Langeler, a general partner at
OVP Venture Partners, points out that people tend to forget that Tektronix also competed in the
computer-graphics display and software spaces, which might account for the broad mix of sectors
represented among the local startups.

Patrick Criteser, principal at SmartForest Ventures, says that his firm looks for disruptive, defensible
technology. Teseda, which develops next-generation design-integrated test products for
system-on-a-chip manufacturers, is a good example. Teseda President and CEO Steve Morris says
that what distinguishes his company from others is that its technology detects silicon defects in the
earlier design phase of chip production rather than in the typical later phase, which ultimately
reduces cost and speeds up time to market. Teseda’s future looks promising, thanks in part to the
growing chip market, which is meeting the demand for chip-embedded consumer-oriented products.

Although Intel’s headquarters is in Silicon Valley, the chipmaker has a large presence in Hillsboro.
Half of the management team of its investment group, Intel Capital, is also based in Hillsboro. Its
strategy of funding companies that impact or support Intel’s businesses demonstrates how varied its
investment choices are in the Portland area: PixelWorks provides chips for high-resolution displays,
RadiSys builds embedded computer systems, WellMed provides health care management software,
and Webridge provides industrial-strength extranets.

Experience, Experience, Experience

Claude Leglise, vice president of Intel Capital and director of its worldwide geographies sector, says
the one characteristic shared by its portfolio companies’ management teams is past experience.
“Because of [Hewlett-Packard], Tektronix, Intel, Nike, and all the large companies around Portland,
there is a good availability of people who have experience building companies. The talent is available,”
he says.

Wade Bradley, founder, president, managing director, and advisory member at Empire Ventures,
agrees, saying, “Having large tech employers [in the area] means you’re always going to have a
steady flow of new people, ideas, and opportunities. Now it’s really more second- and
third-generation. Now they’re coming out of startups.” Before CEO and Chairman Bill Kelly
co-founded Learning.com, which integrates technology into language-arts and math curricula, he
co-founded Sapient Health Network, which WebMD later acquired. Learning.com played a key role in
the development of technology-skills standards for schools and is helping many states adopt those
standards for students in kindergarten through the 12th grade.

Raymond King, president and COO of SnapNames.com, which helps people acquire and manage
domain names, previously founded and sold a company called Semaphore. The market for his current
company is huge, with

45 million names registered worldwide. Its tools get up to 7,000 names for clients per month, and,
with its upcoming release of other infrastructure products, the company is becoming a major player in
the domain-name industry.

Repeat entrepreneur Patrick Cox co-founded Metro One Telecommunications and helped build the
company from startup to IPO, developing close relationships with carriers along the way. Later, when
Cox co-founded Qsent and became chairman and CEO, he was able to leverage those relationships.
Qsent processes approximately 140 million records that are supplied by carriers and charges users
per directory address lookup via a Web browser. The value of the service is wide-reaching and
includes verifying addresses instantaneously for companies like FedEx and helping courts track
down deadbeat dads. “The data itself is one thing, but making it useful, having the highest hit rate,
and having it be as accurate as possible is a whole different level,” Cox says.

Flocking to the Pacific Northwest

Charles Waite, a partner at OVP Venture Partners, says that the difference between the Pacific
Northwest entrepreneurs of the mid-1980s and today is the latter’s experienced management teams.
“What you’re seeing in the last 10 years is a critical mass of people,” he says. The region has
supplied ready markets, an abundant talent pool, and committed venture capitalists for
entrepreneurs. But it also helps that the Pacific Northwest has a relatively low cost of living and is
physically beautiful and unspoiled. For many, living amid forests, mountains, and coastline is reason
enough for natives to stay put and for transplants to flock to and remain in the region.

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