Bets Are On Again-Silicon Valley Venture Capitalists Are Getting Into the Action Again

High technology’s main street is showing signs of life again.

By ANN GRIMES
Staff Reporter of THE WALL STREET JOURNAL

Sand Hill Road, the swank address here for many major venture-capital firms, has long symbolized Silicon Valley’s start-ups. As technology went into a tailspin, the financiers in the low-slung office buildings near Stanford University all but stopped pouring money into new companies. Many venture capitalists left the business; those that remained hunkered down to try to fix, close or sell ailing tech concerns.

But the long dormant period could be coming to an end. Ideas for start-ups are bubbling, and infusions into early-stage companies were up 43% in the second quarter over the previous quarter, according to a survey released this month by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association. "The summer slowdown that used to take place hasn’t happened this year," says Magdalena Yesil, a general partner at U.S. Venture Partners.

The new activity in certain technologies reminds some industry observers of past investment bubbles, where eager venture capitalists piled too much money into supposedly hot technologies only to see most investments fizzle. There is still a distinct memory of the billions of dollars lost in ideas like online grocer Webvan and online pet stores. And critics warn that in certain areas, like wireless-networking technology and eliminating unwanted e-mail, far more start-ups are being funded today than can possibly survive.

"There are a few, frothy, back-to-the-bubble deals," says one Sand Hill Road venture capitalist. Overall however, the atmosphere is still far from the euphoria of 2000, when virtually any business plan seemed able to attract millions of dollars. Few would call this a turnaround. But the second-quarter survey indicates that total venture investments, including both early-stage and more-established companies, rose, albeit slightly, to $4.3 billion from $4 billion in the first quarter.

Among the reasons: After three years of tight budgets, corporations are eyeing new technology, particularly products that can buoy in-house research and development or guarantee a rapid payback in cost-savings. Entrepreneurs, some of them victims of corporate layoffs, have had time to formulate more pragmatic ideas that fit the changed environment. "Unemployment is definitely the mother of invention," says Michael Feinstein, a partner with Atlas Venture.

Other factors include better odds of a financial payoff for investors, shown by the stock market’s rise and the successful public offerings of a few technology companies. So far, only 24 companies have made their public debut this year, but more venture-backed start-ups are in the going-public queue.

Sevin Rosen Funds in Palo Alto, Calif., has invested in a dozen companies to date this year, outstripping its pace for each of the past two years. More investors are "willing to look at a deal with the intention of doing a good one, as opposed to looking at a deal with the intention of not doing one," says Nicholas Sturiale, a Sevin Rosen partner.

But most of the ventures are driven by more practical concerns. "We are open to deals that are solving real business problems, by people who know the industry having the problem," says Allen Morgan, a general partner with Mayfield, another Sand Hill Road firm.

A case in point: Venture funding has flowed into some 75 companies formed to fight the unwanted e-mail known as spam, estimates Michael D. Osterman, an industry analyst. Examples include $10 million for MailFrontier Inc. of Palo Alto; $8 million for FrontBridge Technologies Inc. of Marina Del Rey, Calif.; $7 million for Proofpoint Inc. of Cupertino, Calif.; $15 million for IronPort Systems Inc., San Bruno, Calif.; and $4.5 million for Cloudmark Inc., San Francisco.

Wireless-networking technology is hot, pulling in an estimated $1 billion in funding over two years, according to FierceWireless research, Washington, D.C. Security-related plays are also big.

While semiconductor investing remains flat, interest is high in start-ups aiming to solve one of that sector’s biggest problems: how to minimize the heat generated by ever-shrinking, more powerful and cheaper computer chips. It’s nice to have a little laptop, but not one that burns your knees, says Alexander Wong of Apax Partners.

Biotechnology, energy and medical-device start-ups also have gained steam. Some start-ups are even seeing venture capitalists try to out-hustle each other with attractive funding offers, known as term sheets. ID Analytics Inc., a San Diego company out to combat identity theft through pattern recognition, is one example. "By the time we looked at that in the course of a month, they’d gotten a term sheet from everyone they saw," reports John Balen, a partner with Canaan Partners’ Sand Hill Road office.

Mayfield’s Mr. Morgan likens the environment to the aftermath of a forest fire: "If you look up, you only see scarred pines, devastation and you miss the point. If you look down, there’s a profusion of damned near everything growing out of the ground."

Write to Ann Grimes at [email protected]

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From Wi-Fi to Face Lifts, Ideas of High-Tech Start-Ups Wake Up Venture Capitalists

By ANN GRIMES
Staff Reporter of THE WALL STREET JOURNAL

As venture capitalists show renewed interest in start-ups, certain fields are attracting particular notice. Below is a look at some companies in five of these fields.

Alternative Energy

Concerns about U.S. reliance on oil imports — and problems such as the recent blackout — have sparked new interest in energy ideas. Konarka Technologies Inc., whose name refers to a temple in India dedicated to a sun god, is developing plastic sheeting that rolls out to transform sunlight into electricity.

Konarka, based in Lowell, Mass., believes the flexible material will allow for less expensive and more efficient solar, or photovoltaic, cells. The company sees the possibility for lightweight portable power packs, or energy-storing plastic roll-out tarps — as a way to generate electricity in remote areas.

The U.S. Army was interested enough to pump $100,000 into Konarka’s coffers this month. The state of Massachusetts also has backed the company, with $1.5 million. In June, Konarka closed a second, $6.5 million round of funding with a group led by Draper Fisher Jurvetson, a Redwood City, Calif., venture-capital firm, bringing the total amount raised to about $18 million, the company says. Konarka’s technology will help push the solar cells into the mainstream market, says Raj Atluru, a DFJ managing director.

Split out of the University of Massachusetts Center for Advanced Materials five years ago, the company bases its technology on tiny, dye-sensitized crystals of titanium dioxide, a semiconductor that absorbs the sun’s energy and can be coated on flexible plastic sheets or metal foils. The light stimulates the crystals, which creates electricity.

Most existing photovoltaic, or PV, cells are built using crystalline silicon, which requires expensive processing. While costs for such panels have come down in recent years, the industry still is looking for a breakthrough that will make solar power price-competitive with other forms of energy.

"There is still a lot of debate as to how the solar PV industry will unfold," says Ron Pernick, president of Clean Edge Inc., a San Francisco research company that tracks the industry. "These newer, disruptive technologies offer promise but still have development cycles to go through."

Two other start-ups — Nanosys Inc. and NanoSolar Inc., both in Palo Alto, Calif. — also are using plastics in an effort to manufacture more durable, efficient, inexpensive and flexible solar-power cells. Like Konarka, both are taking advantage of nanotechnology — new techniques for manipulating materials that are measured in nanometers, or billionths of a meter.

With $38 million in funding, Nanosys is making other products, such as chemical and biological sensors. It says its photovoltaic cells, which it estimates will be on the market in 2006, will be able to generate solar power at less than $1 per watt, comparable to the cost of traditional sources for generating electricity, such as fossil fuels.

NanoSolar, with $6.5 million from investors that include U.S. Venture Partners and Benchmark Capital, is using a slightly different approach to make thinner solar plastic sheeting, which it says will result in even more efficient and reliable solar cells on the market in 2005.

Konarka says it will enter the market with a photovoltaic cell in late 2004; it says its cell will generate solar power at around $2 per watt, but the company hopes to achieve lower costs. "If we can get below $1 per watt, we can change the industry," says Chairman Howard Berke.

Medical Devices

Some people may balk at sticking their foreheads under a microwave-like probe to whack off wrinkles. But Thermage Inc. of Hayward, Calif., believes the approach is less invasive than a surgical knife and bound to appeal to aging baby boomers.

Developed eight years ago by a California plastic surgeon, Edward Knowlton, the hourlong Thermage procedure uniformly delivers radio frequency pulses to underlying collagen tissue at the same time an icy cryogen spray prevents the epidermis, or top layer of skin, from being burned.

The technique has been used before in medicine to cauterize and shrink tissue during heart and spinal surgery. Dr. Knowlton says the pulsation causes submicroscopic wounds to the skin; when they heal, the underlying skin tightens and lifts. Doctors who have used the procedure say results can take months to develop as the skin heals — a benefit for those who don’t want to admit to cosmetic work.

The Thermage system, consisting of a $40,000 laser-type machine and a disposable $200 probe, won Food and Drug Administration approval for use on the forehead in November 2002. So far, it has sold 330 units and hopes to turn a profit in the fourth quarter. The price of the procedure depends on the doctor, but Thermage estimates it is $1,500 to $2,000 for a forehead.

The procedure has been tried on hundreds of patients, and some doctors are testing it beyond the forehead. Ronald L. Moy, president-elect of the American Society for Dermatologic Surgery, says he has tried the procedure on the foreheads, cheeks, jowls, necks and stomachs of about 160 patients with varying results. On some, Dr. Moy says, results have been "remarkable." On others, the procedure has had little effect.

Dr. Moy says Thermage is the first company to apply this technology to dermatologic surgery. Dr. Knowlton, who says he has tested the system on himself, adds that the procedure is designed to complement other cosmetic techniques such as laser resurfacing. The company reports some side effects including redness, swelling and, occasionally, an uneven dimpling effect. "It can be painful," Dr. Knowlton says, so doctors use a topical anesthetic.

Dermatologists say they are cautiously optimistic that Thermage is onto something, at least for "younger" people between 33 and 55 who just need a touch up. Long-term effects are unknown and there is the danger of burn injuries if the procedure is done improperly. Results are expected to last five to 10 years.

Michael S. Kaminer, an assistant professor of dermatology at Yale Medical School, has tried the Thermage procedure for a year on about 100 patients. Repercussions have been minimal — swelling and, occasionally, skin irregularities. The procedure needs further study to determine full benefits and long-term effects, he says, but adds: "It gives us the ability to do something [previously] only achievable with surgery."

Gary Shaffer, a general partner at Morgenthaler Ventures, a Menlo Park, Calif., venture-capital firm, was impressed enough to place a $10 million bet on Thermage. He isn’t the only one turning to medical devices; funding in that sector rose 54% in the second quarter.

Wireless Networking

If any sector is bubbling up, it is wireless Internet access, an area that has captured 22% of venture-capital dollars invested this year. One company that has attracted special attention is Vivato Inc. of San Francisco.

Vivato makes a switching device and an antenna for extending the range of the most popular wireless technology, known as Wi-Fi, from about 110 yards to about 2½ miles. A network powered by Vivato could inexpensively cover a corporate or university campus, or even a residential neighborhood, Vivato says.

Started in Spokane, Wash., by a team of former Agilent Technologies and Hewlett-Packard engineers, the three-year-old company has amassed a $67 million war chest and says it turned away investors who wanted to give even more. Vivato closed a third funding round of $44.5 million in June, with backing from Advanced Technology Ventures and Intel Capital, the venture arm of chip company Intel Corp. Intel, hoping to spur demand for portable computers, added wireless technology to a set of chips called Centrino and says it has added at least 15 Wi-Fi related start-ups to its portfolio in the past 18 months.

Vivato recently began shipping its product, a switch that is priced at $9,000 for indoor use and $14,000 for outdoor use. Customers include Indiana University, Florida State University and Freeman Decorating Inc., a Dallas convention contractor that bought six switches to use inside convention halls.

Vivato faces competition from other start-ups, such as Aruba Networks and Trapeze Networks, which are setting similar goals but using different methods. Aruba, based in San Jose, Calif., which emphasizes Wi-Fi security, has raised $9.5 million in venture funding and just closed a large second round that will be announced in September. Trapeze, a Pleasanton, Calif., company, recently closed a $34 million funding round.

Despite skeptics who say that Wi-Fi is overfunded and overhyped, there are believers like Dennis M. diBattista, president of QGO LLC, a high-speed communications company in Pawtucket, R.I.

This summer, Mr. diBattista joined an Internet service provider to attach a Vivato switch to a hotel in nearby Newport, setting up a "hot zone" that spanned a good part of Narragansett Bay. Mr. DiBattista signed up 55 customers, mostly summer visitors and members of the boating crowd. "They check their e-mail on the boat," he says.

Business Services

Fewer trends are hotter, or more contentious, than shifting technical jobs from the industrialized world to lower-cost countries. But 24/7 Customer, Los Gatos, Calif., is determined to help the outsourcers.

The three-year old start-up provides call centers for corporations needing technical support and telemarketing. The company has 2,000 employees — soon to be 3,000 — in two centers in Hyderabad and Bangalore, India, who answer the phones for 24/7’s customers.

The company uses a combination of proprietary and off-the-shelf technology to wring delays, static and echoes out of phone calls that may originate in a U.S. state and are bounced to one of two U.S. networking centers on the East and West Coasts before winding up in India, where the calls are answered and problems solved. The company also uses voice-compression technology to fit more phone calls into the space an uncompressed call would take, says Sudhakar Kosaraju, 24/7’s 30-year-old, Harvard-educated co-founder.

An even bigger selling point, Mr. Kosaraju says, is a proprietary network the company established to allow customer-service managers in Manhattan or London to track performance in India from their home bases. Telemarketers, for example, could check how many sales one of 24/7’s agents is making per hour. In customer-service applications, the customers can monitor how long it takes to answer each call and how often calls are bumped up to a superior. "Like a NASA control center, they know what’s happening and whether they should be asking questions," Mr. Kosaraju says.

Since launching, the company says it has signed up 10 big companies that outsource tasks like technical support and help desks. The company says it expects to hit its profit target of $30 million for fiscal year 2004.

Michael Mortiz, a partner at Sequoia Capital, says his firm took the lead in a $22 million round of funding in the start-up. Sequoia has invested in a variety of service companies, including contract manufacturer Flextronics International Ltd. Mr. Moritz says outsourcing "is a very vibrant place to invest, and 10 years from now people will wonder about companies that operate call-centers in-house."

In addition to expanding its work force, 24/7 plans to use the money to acquire competitors, of which there are many. Besides competition, the company faces growing fears of more U.S. jobs moving offshore in the current tough economy. Mr. Kosaraju says the company was asked by several of its customers — a major U.S. bank and a major U.S. package-delivery service, for instance — to sign nondisclosure agreements, fearing negative publicity. "Especially with the economy the way it is, many have requested these relationships stay confidential," Mr. Kosaraju says.

Video Chips

Investors in four-year-old Pixim Inc. in Mountain View, Calif., are hoping to get a double bang for their bucks, exploiting computer chips and security. The company, which raised a fourth funding round of $22 million in the spring, has nearly $60 million in the bank and is poised to ship products this fall.

Spun out of Stanford University, Pixim makes chips designed to produce much sharper digital video, for use in high-end security cameras and other applications. The technology works much as the human eye and brain do, adjusting for glare and lighting, says the company’s executive vice president, Rob Siegel.

Pixim plans to sell a set of two chips: a sensor that captures light and an image processor. The concept is for every picture element that makes up a digital image — known as a pixel — to be individually exposed with light. Previous technology doused each pixel equally. As they adjust to different levels of light, the pictures are neither overexposed nor underexposed.

The company is part of a wave of chip start-ups that have moved into the world of digital images. Some, like Foveon Inc. of Santa Clara, Calif., have capitalized on digital still cameras; others, following in the lead of Nvidia Corp., synthesize three-dimensional graphics for videogames and the like. "These companies have an opportunity to pick off niches of the semiconductor market," says Mark Edelstone, an industry analyst with Morgan Stanley.

Pixim chips could be used in consumer products such as cellphones that display pictures. But the company decided security was the best way to secure its financial bearings — and that was before Sept. 11. "It came down to which market could we educate faster," says Chief Executive Bob Weinschenk. "Given the economy, the consumer market was questionable. It still is."

Pixim says it has signed up six customers, including several leaders in the security-camera market General Electric Co.’s GE Interlogix Inc., Austin, Texas; Pelco, Clovis, Calif.; EverFocus Electronics Corp., Duarte, Calif; and Baxall, Colorado Springs, Colo.

Bill Unger, a partner at Mayfield, which has put about $18 million behind the company, says he didn’t initially back Pixim as a security play but because its technology offered a higher-quality alternative to chips made by Sony Corp. and Matsushita Electric Industrial Co.’s Panasonic.

Pixim hopes to see its chips used in a range of devices — including safety cameras in cars, facial-recognition systems and even cameras for making video entertainment. There is a connection: Filmmaker Francis Ford Coppola is a member of Pixim’s advisory board.

Write to Ann Grimes at [email protected]