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Lead Investors sift through the rubble of failed startups

It may be summer but for an increasing number of high-tech startups, this is the winter of their discontent.

More than a few tech firms are paring payrolls, the quickest way to cut their monthly burn rates and conserve cash a little longer until they can find more money to keep them running.

For others, the death knell has already come.

BioQ.com, a Carlsbad-based software firm that attracted a total of $15 million, shut down last month because it couldn’t convince new investors they had a viable product.

Joel Smith, the firm’s former CEO, albeit only for a few weeks, said despite the backing from some heavy hitters, including Tullis Dickerson and Accenture (formerly Anderson Consulting), they simply didn’t make any sales.

“Just as we failed to raise money, we also failed to get a customer to buy our software,” Smith said.

BioQ’s demise left a sour taste in the mouth of one of its investors, Dan Wood, a partner in the San Diego-based IngleWood Ventures, which sank $1.7 million into the startup.

“They spent about $15 million and couldn’t produce anything,” Wood said. “They spent money unwisely on lots of things including their tenant improvements. It was mismanaged.”

Expect more closures and failures this year, said most local venture investors interviewed for this story.

“We’re going to see much more of that,” said Robert Kibble, managing partner in San Diego-based Mission Ventures. “The blood has been flowing but it’s going to flow a lot more.”

“The capital sources have dried up quite significantly and those that exist are much more selective than they were before,” said Michael Jones, president of ProFinance Associates, a San Diego-based investment bank.


– Cautious With Investments

Venture capital firms that were throwing money at anything with a dot-com after its name a few years ago are pulling the plug on startups faster than ever today. Without the prospect of seeing investments turn a quick profit by going public, venture firms are trying to limit losses, pumping money into only the best businesses and prospects for making it, Jones said.

“The equity players are husbanding their money in order to continue to feed the best companies in their portfolios and allowing the weaker ones to disappear,” he said.

Bill Carpenter, a local angel investor to several startups, said the current economic climate is causing corporate investors to pull back from putting cash into startups developing a closely linked technology.

Battered themselves by the roiling economy, many of these corporations are making drastic cuts to their own operations and are in no position to dispense additional capital, he said.

Carpenter is among a group of angel investors in Gray Scale Technologies, a maker of specialized equipment used by the semiconductor industry. With that industry facing a huge inventory over-hang and losses, Gray Scale has been unable to convince anyone to invest some $5 million needed to get the company’s operations up to a level where it will eventually require even larger capital infusions.

“Corporate financing has dried up just like the venture financing has dried up,” Carpenter said. “There are a lot of companies that were aggressively investing (in startups) a year ago but are not today. A lot of companies are facing their own cash shortfalls caused by the downturn in the semiconductor industry.”

After approaching about a dozen corporations over the past year and finding no takers, Gray Scale is at a crossroads. It can continue seeking venture capital financing, but its prospects are dim. So is the possibility of getting additional capital from the original investors, Carpenter said.

A more likely scenario is the firm will be sold or simply shut down, he said.


– Money Is Available

Yet not all startups are getting shut out of the financing pipeline.

Another of Carpenter’s investments, DriveCam Video Systems, is close to breaking even, and in a great position to attract additional venture financing to take the firm to the next level.

DriveCam makes a video recording system for vehicles that begins filming at a certain pressure point, thus preserving critical data surrounding an accident.

Founded in 1999 with about $1 million in seed capital, the firm was able to attract another $1.6 million from investors late last year. This year the company expects to post about $2 million in sales, Carpenter said.

Perhaps even a more wildly successful startup finance story concerns PacketVideo Corp., a San Diego developer of software that delivers rich media content over wireless networks.

Founded in 1998, PacketVideo filed documents in March 2000 for a $64 million IPO. Within a few weeks of the filing, the Nasdaq market fell by more than 2,000 points, causing PacketVideo to rethink its plans.

Despite the fallout, the firm knew there was plenty of funding available through the private equity markets and decided it didn’t have to go public after all.

Pete Price, the firm’s CFO, said one of the reasons PacketVideo decided to seek the money from the corporate sector was under the IPO rules concerning a “quiet period,” the company couldn’t conduct a full marketing campaign about its breakthrough technology.

In March, PacketVideo closed a round of about $100 million from Motorola, Qualcomm Inc., Texas Instruments, General Electric, SAIC, Intel and Sun Microsystems.

Though Carpenter and others said PacketVideo is an isolated case, just last week LightPointe, a San Diego-based firm that makes laser optics used in telecommunications networks, was able to attract $33 million in new investment capital, including two troubled corporate partners, Cisco Systems and Corning Inc.

Others point out that there is more venture money than ever before available to startups. According to PriceWaterhouseCoopers, nearly $2 billion in venture funding was invested in San Diego firms last year. Judging from the $595 million invested in the first quarter of 2001, the region is on pace to break that amount.


– Finding Worthwhile Companies

While there’s a good deal more cash around, those making the decisions on where the funds go are scrutinizing potential companies much more closely and eliminating those that may not have revenues for several years, can’t show a clear road to profitability, or don’t have a clearly defined business plan.

“There’s a whole host of companies that will not be able to get another dime because they can’t articulate a clear business model or a story of sustainability,” Price said.

The Federal Reserve Bank’s reduced interest rates intended to make capital more available to businesses isn’t helping most startups, said Jones.

For the most part, banks will not even consider lending to new businesses that aren’t making a profit or haven’t been around very long. In addition, while the Fed lowered interest rates, it is tightening lending criteria, making it tougher for banks to extend credit, Jones said.

All of this could have serious long-term effects on the region’s economy, said Carpenter.

The amount of deals coming to venture funds and angel investors is declining.

“Entrepreneurs are getting so discouraged, they’re not submitting their plans to potential investors,” he said. “There’s such a tight money environment, and pre-valuations are much lower, that many of them are saying forget it. A lot of ideas are staying in the garage and it’s a shame.”

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