Indeed, although Silicon Valley's venture capital titans have hogged
the limelight over the past decade, few have Patricof's depth of
experience in watching -- and weathering -- the cycles of investment in
technology that periodically ripple across the U.S. economy, flattening
some businesses as they create others.
In 1969, he launched Patricof & Co., a firm that would help give birth to Valley mainstays such as Apple Computer Inc. of Cupertino, Calif., and Cadence Design Systems Inc. of San Jose, Calif., as well as East Coast startups America Online Inc. (now owned by New York's Time Warner Inc.) and Office Depot Inc. of Delray Beach, Fla. As his firm evolved into private equity giant Apax Partners Worldwide LLP,
Patricof also took stakes in media assets, including New York magazine,
the Village Voice and Details magazine, while taking time to advise the
Clinton-era White House on small business affairs.
Patricof, 74, is now drawing on that experience in preaching calm as
the financial crisis buffets tech companies nationwide. "It is in times
like these that great opportunities are created," he told The Deal
recently in response to the growing storm, which threatens to stifle
funding in tech startups and seal markets for initial public offerings
and mergers and acquisitions for years to come.
In this interview, Patricof suggests that new-media companies are
better prepared for an economic downturn than startups seeking to
develop new technologies. Some may even be prepared for exits, as media
companies take advantage of consolidation to buy, rather than build,
additional features. And while he advises startups to proceed with
caution as the economic clouds darken, Patricof urges investors and
entrepreneurs not to panic and to look for the business opportunities
that inevitably arise with each passing storm.
The Deal: You've been in the growth capital business long
enough to have survived other downturns. Now that fallout from the
financial crisis is hitting the tech industry, what's your prognosis
for venture capital investment and for industry startups?
Alan Patricof: I think people have to recognize
there's a fundamental difference between, say, the environment from
1998 to 2002 and today. We don't invest in young companies today with
the concept of taking them public. That possibility has been foreclosed
at least for the last three to five years, if not longer. Most
investment banking firms, if not all of them, have gotten to the level
where if you don't have a market value of a quarter of a billion
dollars to support a public offering of, say, $50 million, made up
perhaps of a few selling shareholders and mostly new capital being
raised, you can't establish liquidity.
In addition to that, most of the small investment banking firms
known for creating the new-issue market -- the Unterberg, Towbins, the
Hambrecht & Quist of the old days, Robertson [Stephens], the old
Montgomery Securities -- have gone away. So the fact that there haven't
been any new issues for this year has had no impact.
We have 24 companies in our portfolio, and when we were considering
investing in any of them, we didn't say, "We're going to take this
public in two years or three years and try to extrapolate a public valuation."
We approach the market on a very realistic basis, and I think most
people in the business do. For the most part, our companies are either
going to make it on their own as freestanding enterprises that generate
their own profitability and cash flow, or they're going to be sold to
I think if one approaches the market for venture opportunities in
that context, keep valuations at a reasonable level and keep the amount
of capital commitment at the earlier stages to a limited level, then
one can do very well in a shorter time frame than existed before. And
that's because there are a lot of corporate buyers around that are
interested in acquiring young companies that have shown some traction
and fit in with their overall strategic objectives.
Does that imply that, despite the lid on IPOs and challenging
M&A environment, younger technology companies are fairly well
insulated from all this?
No one's insulated. And I should add, we're really focused on
applications, Internet and wireless markets rather than any
breakthrough in technology -- I mean by "technology" to imply the
creation of new inventions.
From our standpoint, we're able to find opportunities that can get
pretty far along with reasonable amounts of capital -- $2 million to $5
million -- compared to what we'd done in the late '90s and early 2000s,
with initial capital structures of $5 million to $15 million.
Because of the advancements of technology and because of perhaps a
more cautious approach on the part of entrepreneurs who saw what
happened, entrepreneurs are being more realistic in their capital needs
at the younger stages of development until they have really proven the
commercial potential of their projects. And I think that will serve
them in good stead during these difficult times.
So entrepreneurs who have learned to keep their burn rate low are
better prepared for an economic crunch. What other qualities do such
startups -- let's call them the "survivors" -- have in common?
It's anyone who focuses on having enough capital to get through the
period when they can demonstrate solidly that they have a commercially
viable enterprise. But if you say, "I'm going to finance for the
first year and be in the middle of development," that's an invitation
to disaster, particularly in this environment. I don't think that makes sense.
I think you've got to make sure that as an entrepreneur, you've
financed your operation sufficiently to get someplace where you've
proven something. And for a venture capitalist, that means you've
financed it adequately to get to that point -- say, someone's bought
what you've got and perhaps will come back for more.
So what does that mean for the legions of "Web 2.0" companies
that have yet to generate much revenue and are focusing on attracting a
critical mass of users?
There are lots of companies that have registrations and unique
visitors and page views that haven't worked through their commercial
model. And it's critical that they're adequately financed to test out
their assumptions and get to the point, realistically, where they can
have a demonstrable revenue model.
What I was referring to are ones that will have difficulty, that
have long-range development plans that they can't adequately fund on a
reasonable basis up front. And that's one of the reasons why we avoid
specific new technology. We leave that to the Silicon Valley guys who
are prepared to put larger amounts of capital into longer-range
development programs for new semiconductor applications or new optic
designs -- new inventions, in other words.
Some prominent VCs have sounded the alarm in recent weeks about
the need for startups to conserve cash, and a number of emerging tech
companies have announced layoffs. Do you see a difference in the way
things are playing out between the startup and innovation culture in
Silicon Valley and what you find on the East Coast?
We think it's too early to have any conclusion about that. I have
certainly canvassed all our companies, counseled them to be cautious in
their spending. And we've particularly focused on the fact that there's
a great tendency among young companies to have new features. It's never
enough -- you always have to add something that makes the product
better and better.
And I think this is a moment when, if you don't hear the customer
saying, "We're not buying because you don't have this feature," this is
a time to cool it on adding every bell and whistle and focus more on
selling the product that you have with modest refinements. You may not
want to undertake any long-range development programs that won't
translate into revenues in the near term, meaning the next 12 months.
For years now, many big VC funds have been moving away from
early-stage investing to concentrate on later-stage deals in pursuit of
more lucrative exits. Do you see any trends in the capital markets that
might reverse that trend?
I don't think so. Later-stage companies that are running out of
capital are therefore more likely to be affected by these economic
cycles. They're in revenue stages and need working capital lines or
venture leasing. If they haven't reached profitability, they're the
ones who are going to have more difficulty finding money because
they're in that middle ground.
That'll make for a tighter, tougher market for the companies that are further along and haven't reached profitability.
Given the dire predictions for consumer and enterprise spending
in the U.S., what longer-term implications do you see for startup
companies, whether full-fledged developers of new technology or makers
of applications or features derived from those innovations?
For a new company with truly innovative technology that has a lot of
research, development and experimentation involved, it's going to be
harder to finance those kinds of enterprises because of their long
If you're dealing with companies with applications that can be
translated into a product in a shorter time frame that can make your
customers do something faster and cheaper, you'll be fine. You're going
to be relieving a pain point and there's a real need for your product
regardless of the economic environment.
What about on the fundraising side? How serious are the fears
raised in some quarters that limited partners will shy away from
investing in new funds or even fail to honor capital calls?
Our LPs don't call us. We try to keep them up to date on what we think is happening in the market.
In general, I would say almost without exception that we don't
expect any defaults -- we don't foresee any indications of that. No one
has expressed concern about funding. I'm not living in a dream world,
but I don't foresee this happening, not with the kind of people who are
participating in this marketplace.
I'm sure there will be an exception, but it will be the exception and not the rule.
What are some of the key trends you see emerging under the next
presidential administration that are likely to affect VCs and
One important trend is that we're certainly going to have more
regulation. They'll be careful to avoid over-regulation, but we're not
going to be as foot-loose and fancy-free in a lot of areas.
I also think that carried interest is going to be taxed as ordinary
income, which is something that is of interest to a lot of general
partners. The capital gains rate will probably also go up. On a macro
basis, we're going to see a lot more public assistance.
As for innovation and technology, particularly under a Democratic
administration, there'll be more money for the National Institutes of
Health. I think research and development will be emphasized and that
any programs that will result in job creation are going to have a high
What sorts of companies or entrepreneurs will be best positioned
to capitalize on the ongoing economic malaise to build important new
It depends on the individual company; I can't speak for all of them.
But something to look at are people who can deliver a product that will
save people money and time, and efficiently. Buyers are now looking for
things that they need -- they're going to be a lot more careful and
less casual about what they'll buy. If you have something that has a
good story attached to it and a good benefit in the near term, you'll
be in a good position.
Where do you see this latest economic cycle fitting into the larger story of the venture equity and growth capital industries?
I don't think it's going to change that much. We've been through so
many of these cycles; everything doesn't go in one direction. Most
people will be survivors in the venture business. The major difference
is that public markets will no longer be the principal exit.
I think it's a question of running your business carefully. Perhaps
there'll be a few more casualties -- investors won't support every
company until the end of time. They'll be a little more careful. But
long range, the business will come out of it, and we'll be fine.
We came out of 2000, the so-called nuclear winter, after companies
had overexpanded, venture people put too much money in, the losses were
too big and nothing was appropriately scaled. And today the situation
is more rational.- Paul Bonanos
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