Venture Capital Moves East to Silicon Alley

February 7, 2000

Venture Capital Moves East to Silicon Alley

By SAUL HANSELL

EW YORK -- It was the sort of "elevator pitch" that Timothy C. Draper listens to every day -- a business plan breathlessly delivered to an impatient listener.
Four entrepreneurs -- three in their 30s and the obligatory gray-haired chief financial officer -- were rushing last Tuesday to describe a business they hoped would be the next big thing on the Internet. In this case, it was a service called Sticky Networks, which hopes to let people search the Web using pictures rather than words.
They knew that Draper's venture capital firm, Draper Fisher Jurvetson, based in Redwood City, Calif., could help finance their business and, more important, open doors with its prestige.

Source: Venture One

Draper peppered them with his usual questions: Where did you go to school? What have you done before? What is the business model? What's to stop anyone else from doing the same thing?
But there was one thing that was quite different from Draper's routine. This pitch was not in the conference room of his office in Silicon Valley, but in a 39th-floor suite of the New York Palace Hotel, overlooking Rockefeller Center and the heart of New York's corporate life.
Attention New York entrepreneurs: The checkbooks have landed.
When the first people tried to start Internet companies here in the mid-'90s, they had to scrounge to raise money. To their chagrin, the big Silicon Valley venture capital firms like Draper largely shunned New York as a backwater with no history of entrepreneurship or technological innovation.
But now with the success of a wide range of Internet and new-media companies in and around New York City, including the stock market darlings DoubleClick and StarMedia Network, there are an abundance of new and newly expanded venture capital funds in New York, with many hundreds of millions of fresh dollars looking for young Internet businesses to invest in -- in hopes of a big payoff when the company eventually goes public or gets acquired.
"The vacuum of venture capital on the East Coast has been filled," said Alexander D. Lynch, a partner at Brobeck Phleger & Harrison, a law firm that represents a number of Internet start-ups. "There is so much money chasing deals from the existing funds and the new funds. This is now a very good market to raise money if you are an entrepreneur."
Of course, some investors have begun to wonder whether there may soon be too much money chasing too few marketable business plans in Silicon Alley -- a label that once denoted the new-media scene in downtown Manhattan but now refers loosely to Internet-related activities throughout the metropolitan area.
What is clear is that some Wall Street powerhouses that used to ignore deals that could not be measured in the billions -- including Kohlberg Kravis Roberts, the leveraged buyout tycoons -- now deign to put mere millions into digital start-ups. Established New York venture capital firms -- like Venrock Associates, the Rockefeller family's venture investing arm -- are embracing the sort of Internet deals they would have snubbed even a year ago. And the few firms that did invest early in Silicon Alley are growing much larger.
Bear Stearns' Constellation Ventures and Wit Capital's Dawntreader fund, for example, are both said to be in the process of raising new funds of more than $200 million each.
And Flatiron Partners, perhaps the most prominent New York Internet fund, is investing money on behalf of Chase Manhattan at an accelerating pace.
Meanwhile, many more people with money and rich friends are for the first time putting together funds to seek their fortunes as venture capitalists. One of these is I-Hatch Ventures, a new fund started by Chip Austin, former head of Bertelsmann's online bookstore; Derek Reisfield, who once ran CBS' Internet unit; and Brad Farkas, a former venture capitalist at Lazard Freres. I-Hatch expects to raise $150 million, an unusually large amount for a first-time fund.
Perhaps most significant, a number of Silicon Valley venture capitalists are expanding into New York. Draper, for example, hired two former Wall Street executives who had been trying to start their own fund -- Dan Schultz and Ross Goldstein -- to open a New York affiliate, Draper Fisher Gotham, which had an elaborate debut party last Wednesday at which Draper appeared in a Batman costume. It also made its first investment last week: Mimeo.com, a sort of Internet Kinko's that plans to offer express shipment of copied documents; Draper has not yet decided whether to invest in Sticky Networks.
And Adam Dell, who late last year left Crosspoint Venture Partners, a Silicon Valley firm where he was a partner, has started Impact Venture Partners, a $100 million fund in New York devoted to business-to-business Internet investments.
"There is a great opportunity here because there are so many old-line companies that will be reinvented on the Internet and so many great operations people," said Dell, who is the younger brother of the computer mogul Michael S. Dell. "And on the East Coast there just aren't the sheer number of investment firms that exist on the West Coast."

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(March 18, 1998)

To be sure, the $760 million in venture capital investments in New York during the first nine months of 1999 was dwarfed by the $8.1 billion invested in Bay Area start-ups during the same period, according to Venture One, a San Francisco market research firm. But New York venture investments were increasing at an annual rate of 205 percent from a year earlier, compared with a 145 percent increase in Silicon Valley.
New York is growing as an Internet center because most of its traditional industries -- finance, retailing, broadcasting, publishing, advertising and the rest -- are becoming more involved than ever in the Internet and the Web.
"The West Coast creates technology and the East Coast creates brands," said Robert H. Lessin, chairman of Wit Capital. "Now that technology is becoming off the shelf, companies need media companies as partners to build their brands. And every media company other than Disney is here."

In addition to investing in Internet start-ups, Wit has helped companies trade equity for promotion. Wit, for example, last year helped Iwon.com, a Web site that offers its users chances to win cash prizes, obtain broadcast advertising time on CBS in exchange for CBS's acquiring a stake in the company.

As elsewhere, venture capitalists in New York are now looking to invest much earlier in a company's life cycle than venture investors did in the past. That is because the stock market nowadays is willing to embrace initial public stock offerings from companies so young they barely have any revenue -- let alone profits. So companies do not need to go back and raise the traditional second or third rounds of financing that venture capitalists previously specialized in.
Few venture funds want to wait that long, given the buoyant market for the stocks of Internet companies, which have made astounding profits for the earliest investors in such companies.
"We have seen fewer opportunities to invest at later stages, so we have refocused our energy on earlier-stage investments," said William E. Ford, a managing partner with General Atlantic Partners, a $2 billion, 20-year-old venture fund in Greenwich, Conn. General Atlantic, for example, invested in Priceline.com before it even opened for business -- something Ford's firm would never have considered in the pre-Web days.
Meanwhile, the smaller funds are moving to compete with the so-called "angel investors" -- wealthy individuals who traditionally provided initial grubstakes to companies too young to seek financing from the venture funds, which are run by professional money managers and which pool the resources of many investors.
New venture funds, like I-Hatch, now play the role of an angel investor. "We want to find the guy as he is just looking for the cocktail napkin to write his idea on," Austin of I-Hatch said.

Like all venture capital firms, I-Hatch hopes to attract companies with its advice and business contacts as well as its cash. I-Hatch, in other words, helps do much of the work that the entrepreneurs themselves formerly had to do before daring to ask anyone for funding. "We help people refine their fuzzy ideas and get to the next level," Austin said.
In addition to advice, investors like I-Hatch and Rare Medium -- a Web development firm with a venture capital arm -- are setting up "incubators" where very young companies can receive office space and technical services in return for equity stakes.
Draper's new New York affiliate will not go as far as providing office space, but Draper says the companies it backs receive something even more useful: invitations to the firm's frequent cocktail receptions, where the 200 other companies backed by Draper affiliates in Silicon Valley, Los Angeles and Virginia can flirt with each other and form alliances.
"An Internet company is only as valuable as the deals it has made," Draper said.
Of course, determining the value of an Internet company can be a conundrum for venture capitalists these days, especially when the company is at the "pre-revenue" or even "pre-cocktail-napkin" stage. The frenzied competition among venture firms, and among the firms and angel investors, is causing some qualms in the investment community.
"We'll see a company with great prospects, but it is overpriced," said Clifford H. Friedman, managing partner of Constellation Ventures. "The angels invested at a $25 million valuation, and we think it's worth only $15 million or $20 million. That's not a comfortable situation and we've lost some deals because of it."
To Fred Wilson of Flatiron Partners -- which was an early player in Silicon Alley, having been formed way back in 1996 -- this surge in investment at ever higher values is a sign that there is in fact too much venture capital in New York.
"The rate of company creation going on is unsustainable," Wilson said. "I would not be surprised if there were 20 or 30 new Internet companies a day being formed in New York. That's scary.
"People are forming companies for the wrong reasons," he added. "They aren't passionate about their ideas. They just want to be millionaires like all their friends, and there is so much capital in New York that anybody can start a company today."

Related Sites
These sites are not part of The New York Times on the Web, and The Times has no control over their content or availability.

Sticky Networks

Draper Fisher Jurvetson

DoubleClick

StarMedia Network

Kohlberg Kravis Roberts

Venrock Associates

Constellation Ventures

Wit Capital

Flatiron Partners

I-Hatch Ventures

Mimeo.com

Impact Venture Partners

Venture One

Iwon.com

General Atlantic Partners

Priceline.com

Rare Medium

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