Allegis Capital: A New Venture Capital Model for Today’s IPO-Free Market

When you’ve been covering a beat for 15 years you think you know pretty much everyone you need to know. But one of the great things about Silicon Valley is the technology industry’s depth of talent. There are so many high quality people and it’s a blast when you make a new connection.

So it was a real pleasure when recently met Robert Ackerman, the co-founder of venture capital firm Allegis Capital. Check out this story I wrote this week about Bob and his venture firm, which is doing some real innovative work on the venture scene. As an extra bonus for my blog readers, I also added a two-minute video I shot with Bob at the office that wasn’t included in the BW article.

Can Venture Capital Come in from the Cold?
Allegis Capital and a handful of boutique firms are eyeing new investments amid a crisis of confidence among Silicon Valley VCs

By Spencer E. Ante

These days, many venture capitalists resemble mice, afraid to invest in the rough economy. But a few firms remain upbeat and aggressive, ready to pounce like a tiger.

One is Allegis Capital, a 12-year-old Silicon Valley VC firm that’s smelling opportunity amid a fearful market. Allegis doesn’t have a marquee name, but it’s put together one of the most impressive track records of any venture firm in recent memory.

Last July, Allegis sold Ribbit, a telecommunications provider it backed, to BT Group (BT) for $105 million. In 2007, it sold computer security company IronPort Systems to Cisco Systems (CSCO) for $830 million. Over the past four years, six companies in which Allegis has invested have sold for a total of $2.1 billion. “Venture capital is not broken,” says Allegis Managing Director and co-founder Robert R. Ackerman Jr. “Innovation is alive and well.”

That’s not the conventional wisdom in venture investing. The market for taking startup companies public has ground to a halt. The value of startups has fallen. And avenues for selling companies to corporate acquirers have narrowed while fundraising is scarce. Some investors have asked whether the venture capital playbook of raising large sums of cash and betting on a few home-run deals is in need of revision.

Yet smaller funds such as First Round Capital, Maples Investments, and angel investor Ron Conway’s Baseline Ventures continue to invest amid the economic downturn.

Read the rest of the story here.

Michael Moritz: Lessons from a Long-Ball Hitter

Yesterday, BusinessWeek published my profile/Q&A with venture capitalist Michael Moritz. The news cycle is insane these days, so I am reposting the top of the piece here as well as a link to the rest of the interview. Plus, Moritz doesn’t give many interviews, so it’s worth spreading the thoughts of perhaps Silicon Valley’s most successful investor.

Michael Moritz: Lessons from a Long-Ball Hitter
The journalist-turned-venture capitalist was early to ring the alarm bells about the weakening economy, but he remains optimistic

In 1984 a young British journalist named Michael Moritz wrote a short piece in Time magazine about the legendary venture capitalist Arthur Rock with the title “The Best Long-Ball Hitter Around.”” Today, the 54-year-old Moritz is the guy who swats investing home runs as a partner with the Silicon Valley venture capital firm Sequoia Capital. Moritz joined the firm in 1986 after leaving Time (TWX) and writing a book about Apple (AAPL), The Little Kingdom: the Private Story of Apple Computer.

The deal that made Moritz’s reputation as one of the top venture capitalists in the business came in 1999. That year he pushed Sequoia to make a $25 million co-investment with Kleiner Perkins in a little search company called Google (GOOG). When Google went public five years later in 2004, Sequoia’s $12.5 million investment was worth just over $2 billion—160 times its original bet. Before then, Moritz had put himself on the map with investments in Yahoo (YHOO), eToys, and Flextronics (FLEX), among other successful Web startups. Since the Google deal, Moritz has maintained his slugging percentage, scoring another big win with his investment in PayPal, which eBay (EBAY) bought in 2002 for $1.5 billion.

Moritz typically shuns publicity. But in early February I met him at his office on Sand Hill Road, in the last office park on the lane that serves as home to the kingpins of venture capital. A secretary ushered me into a conference room, but when Moritz showed up he invited me to sit in his office.

Efficiency, Even While Eating
Moritz wore the standard business casual uniform of the Valley: striped dress shirt and slacks, with a sport coat hanging on the wall. He has a small and simple office, with a desk and a table with a few chairs, and a window overlooking the woods. An old and weathered notebook case rested on the table. On his desk sat an Apple (AAPL) iMac computer, an Apple laptop, and a BlackBerry (RIMM), all plugged into the wall. Having visited China seven times last year, Moritz needs to recharge his batteries when he returns to the Valley.

When reporters interview people over lunch, they often can’t find enough time to eat. But Moritz was extremely efficient, downing a fruit plate and Cobb salad, even while picking out the eggs and bacon to set them to the side of the plate. As we discussed the history of Sequoia Capital, the state of Silicon Valley, and the future of investing, Moritz would stab a fork into a group of berries, stick them into his mouth, and gaze off into the distance, before offering up some quip or bit of insight.

Moritz’s presence belies his firm’s reputation for toughness. While Sequoia has made many bold bets over its 36-year history, it has also gained a reputation in some quarters for walking away from portfolio companies that fail to perform. As one head of an investment firm that invests in venture firms put it: “They take the portfolio out back and shoot it. They stop funding companies quickly if they are not working.” Moritz calls the criticism “unfounded” and says there are several instances when Sequoia and its startups “soldiered forward together when times were very bleak.”

Pivotal PowerPoint Presentation
Sequoia’s hard-nosed nature was accidentally put on display last year when Moritz’s firm put together a PowerPoint presentation detailing the coming economic downturn in stark terms. The 56-slide presentation advised companies to cut costs and become cash-flow-positive more quickly in order to avoid falling into a death spiral. Although the presentation leaked out on the Web, Moritz swears the leak was not intentional. “A couple of the CEOs asked us to send them the presentation to help them convince their management teams that this was the deal,” says Moritz. “It was not a cynical attempt to spread the Sequoia name.”

Even though Sequoia was early to ring the alarm bells about the weakening economy, Moritz says he remains optimistic. He is particularly excited about two recent investments he led. One was in digital camcorder maker Pure Digital Technologies, which he claims is the world’s leading maker of digital camcorders, having shipped 1.5 million units last year. He is also bullish about another investment in Green Dot, which he says is a leader in prepaid credit cards. And contrary to word on the street, Moritz says Sequoia still invests in young seed-stage companies from time to time.

The day I met him, in fact, he said he was talking to a 20-year-old about investing $500,000 in an embryonic idea. (He wouldn’t discuss the venture in detail.) “It’s as easy for me to be excited today by the unknown 23-year-olds as I was in the past,” he says. “Those sorts of encounters lift your spirits in imagining what is possible.”

Here’s an edited version of my interview with Moritz:

Can great companies be built in bad times?
Some of that is true. In bitter and cold times only the brave are going to venture out into the cold and the lily-livered posers are going to stay tucked into their bed clothes. It makes life easier for us. The people we are meeting are the genuine article as opposed to the pretenders. The only people who venture out are on a mission, which is what you need.

Click here to read the rest of the interview.

Startups in a Downturn

Today, BusinessWeek published my feature story, “Startups in a Downturn.”

It’s about the idea that great companies can be built during bad times–an idea I’ve been talking about a lot lately on my book tour. It seems to have struck a bit of a nerve. It was the most emailed story on the site and the third most read story. This historical oddity occurred to me during the research for my book when I realized that American Research and Development invested $70,000 in the 1957 recession in Digital Equipment Corp., which turned out to be its best investment ever.

Here’s the top of the story:
Startups in a Downturn
Entrepreneurs who helped build their startups into tech stalwarts—companies like Cisco, Oracle, and Google—share lessons on how to thrive during tough times

December 1987 was no time to be raising money for a startup. Computer engineer Len Bosack was trying to attract funding for a young enterprise called Cisco Systems (CSCO). But the stock market had just crashed and the Dow Jones industrial average had plummeted 40% since October. Gun-shy venture capitalists either didn’t get the newfangled technology or deemed it too risky.

Making matters worse, Bosack was running low on the savings he had used to bootstrap the business, and competition was gaining steam. It wasn’t until this 75th meeting that he found a receptive audience. The willing financier was Donald Valentine of Sequoia Capital, a venture capital firm in Silicon Valley. On Dec. 14, two months after Black Monday, Sequoia invested $2.5 million in Cisco. “Valentine’s reasoning was pretty simple,” recalls Bosack, now CEO of telecom gear-maker XKL. “It doesn’t matter what they are. They are selling stuff in a bad market. With a little bit of capital and more experienced help they should be able to do better.”

Better is just what Cisco did. By the time of its initial share sale three years later, in February 1990—during a recession—the maker of telecom networking equipment was worth $224 million. Within a decade, Cisco Systems had become one of the world’s most valuable companies.

GREATNESS CAN EMERGE FROM A SLUMP
Today, some of America’s sharpest financiers and entrepreneurs say Cisco’s story holds a profound lesson easily forgotten amid financial turmoil: Great companies can be built during tough times. “For us, Cisco is always the company we think of when we think about bad times,” says Michael Moritz, a general partner with Sequoia Capital who was a young associate when the firm made its investment.

Cisco is just one example. In the history of technology, many other great companies either were founded during downturns or forged business models during bad times. In 1939, at the tail end of the Great Depression, two engineers started Hewlett-Packard (HPQ) in a garage in northern California. During the recession of 1957, Digital Equipment, the first computer company to challenge IBM (IBM), set up shop in a Civil War-era wool mill, sparking a high-tech boom in Massachusetts. “It makes sense to do research and development counter-cyclically,” says Tom Nicholas, associate professor in the Entrepreneurial Management Group of Harvard Business School. “Recessions can be really useful strategic opportunities.”

Click here to read the rest of the piece.

Telecom Monday: Telcos Face the Credit Crunch and Moto’s New Android Phone

Today, BusinessWeek Online published two must-read stories. One, by my colleague Olga Kharif, breaking the news that troubled handset maker Motorola is hard at work developing its own Android-based device.

Writes Olga:
“Motorola has been showing spec sheets and images of the phone to carriers around the world in the past two months and is likely to introduce the handset in the U.S. sometime in the second quarter of 2009, according to people familiar with Motorola’s plans.”

The second story, written by me, explains why the telecom industry won’t be able to escape the wrath of the financial crisis.

Writes me:
“Although most analysts believe the damage won’t be nearly as bad as the last telecom bust—when hundreds of firms went bankrupt, including giant Worldcom—there is growing evidence that the financial crisis is going to depress the debt-heavy telecom industry. To start with, rising capital costs are likely to take a bite out of earnings. In addition, the softening economy will probably crimp demand for such telecom services as land lines, cell phones, and Internet connections.”

Riverbed CEO: We Can Get Through This

Riverbed Technology has enjoyed one of the best-performing tech IPOs of the last two years. Sales of its networking gear that speed the delivery of bandwidth-hogging corporate applications have been soaring. After going out in September 2006 at $9.75, Riverbed shares steadily rose to a high of $52 last October. Since then, the stock has lost its oomph, falling about 60% to around $22 today.

Riverbed CEO Jerry M. Kennelly, a big friendly bear of a man who was a former executive at Inktomi, stopped by the BusinessWeek office last week to talk about his business and why he thinks Riverbed can keep growing through the telecom slowdown.

Will the slowing economy have an impact on the communications business?
I don’t know. There are reasons to be optimistic. We just had our biggest quarter ever.

Then why did your stock get crushed after the Feb. 6 earnings announcement, dropping 11%?
We gave our first ever-guidance. We matched earnings per share guidance for the year and raised our annual revenue guidance. But our first quarter earnings per share target was below guidance. Analysts thought we hired a bunch of sales people. But we just paid out larger sales commissions.

Cisco, the world’s largest maker of networking gear, just spooked the market by lowering its revenue guidance for the year. How is the slowing economy having an impact on your business?
We have a strong pipeline. It was the biggest pipeline in the history of the company. It’s a multiple of our next quarter’s sale goal.

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So you haven’t seen any softness?
We haven’t seen it yet. If we get through the March and June quarter we’ll be in good shape. We’re constructively paranoid and cautiously optimistic.

Why no impact yet?
We sell a product that’s useful to companies in hard economic times. It saves money and makes employees more productive. Compared to Cisco switches and routers, there is a big untapped market for this product. Everyone who needs a router or a switch already has one. They are selling into a mature market. If the economy sneezes they will catch a cold. We can dodge that bullet. We’re new and unsaturated. And it’s a cost-saving product.

What are the cost savings?
They come from consolidating servers in your data center, and because our machines provide greater throughput. We create free bandwidth through our compression technology. That saves money.

You have a lot of customers in the financial services industry, such as Goldman Sachs and Citigroup. Wouldn’t they cut back?
Banks don’t go to zero. They defer $10 million of a $100 million. You just have to make sure you are not in the deferred $10 million. Only 10% of our revenue comes from financial services. We’re very broadly dispersed. We can get through this.

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Tech CEO Survivor

This week, eBay CEO Meg Whitman announced she was stepping down after a ten-year run. That got me thinking about what other tech leaders may be headed for the exits in 2008. Check out this video in which BusinessWeek reporters Stephen Baker, Heather Green, Catherine Holahan and Spencer Ante play CEO survivor–and also talk about technology and the Presidential elections, and why the Internet is so annoying sometimes.

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Tech Dominated by M&A–not IPOs

A few days ago, I offered readers my forecast for tech IPOs in 2008. But in many ways, the real action–and most realistic exit strategy-for the lion’s share of startups is to be swallowed by some bigger fish. This point was driven home to me when I saw a recent end-of-year M&A report from America’s Growth Capital. Last year, there were 307 tech mergers or acquisitions, down 19% from 381 in 2006. That compared to 60 tech IPOs–a ratio of about 5 to 1.

The disparity in the importance of the IPO market and the M&A market really becomes clear, though, when you look at the value of the transactions. Last year, as of 12/19, there was $203 billion worth of tech M&A deals, compared to just $7 billion in capital raised through IPOs. That’s a ratio of 31 to 1!!!

Although the number of tech mergers declined, the value of those transactions soared 46%. The main reason? The explosion of huge private equity buy-outs. The number of tech deals exceeding $1 billion soared 38% last year. And four out of the top 10 largest deals were handled by private equity shops: Kohlberg Kravis Roberts acquired First Data, Silver Lake Partners bought Avaya, Madison Dearborn Partners scooped up CDW and The Blackstone Group took over Alliance Data Systems.

So what does this portend for 2008? With the private equity biz in a deep freeze, I would expect that we’ll see a significant decline in both the number of deals and the total value of transactions. That leaves good ol’ corporations as the main predators.

The prevailing business model, er, I mean, fantasy in Silicon Valley today is to be acquired by Google. But Google is not the most acquisitive tech company. Here’s the list of top 10 acquirers in 2007:

Microsoft (17)

Cisco (15)

Google (14)

Oracle (12)

EMC (12)

Hewlett Packard (11)

IBM (11)

Interactive Corps (9)

Yahoo! (6)

Nuance (4)

eBay (4)

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