By Tom Henderson
Small Times Senior Writer

Despite 13 months of doom, gloom, cascading share prices and withering stock options in e-commerce, there is good news to be found for some small tech entrepreneurs, say those who ought to know — the venture capitalists.

Entrepreneurs in MEMS, microsystems and nanotechnology — who couldn’t get a phone call returned a year ago because they weren’t in e-commerce — are now getting business plans read and checks written.

And VC folks with money to invest say they haven’t seen valuations this attractive in at least two years.

“From our perspective, this is an awesome time to be investing,” says Tom Erickson, general partner


William Robbins and
Convergent Ventures
are targeting small
tech start-ups in L.A.
of BlueStream Ventures, whose $280 million fund closed last July. “We’re seeing significantly lower valuations.”

BlueStream, a Minneapolis-based firm that focuses on next-generation Internet and optical infrastructure, so far is only 30 percent invested with its 11 portfolio companies.

Not only is he finding better deals, Erickson says, but his fund’s young status gives him an advantage over maturing funds that are holding ailing e-commerce companies in their portfolios. “A lot of VCs are spending too much time looking at their existing portfolio. What to keep. What to jettison. We don’t have those kinds of companies in our portfolio,” he says.

BlueStream’s investments include a stake in Calient Networks, which closed on $225 million in a third round of financing in January to support development of its photonic, all-optical switches.

Calient also made a strategic move in acquiring Kionix, an Ithaca, N.Y., MEMS fabrication company that, says Erickson, will help Calient overcome manufacturing and packaging hurdles in getting its photonic switches to market.

Other BlueStream companies include Bandwidth9, which makes tunable lasers; Pirus, a storage-networking company; and Onetta, Semrock and Xalted IP Networks, makers of optical switching components.

Despite the ups and downs of the optical sector — start-ups by the dozens, a gold rush of deals for would-be makers of optical networking components and falling share prices by established companies — Erickson remains confident.

“This is still such an opportunity,” he says. “I liken optical to where the semiconductor industry was 25 years ago. A lot of successes will shake out.”

Erickson even sees having a market conglomerator like JDS Uniphase to be a competitor as a market advantage, not a market hurdle, for a young fund buying stakes in young, small companies. “JDS has built a huge company through its acquisitions, but companies want more than one supplier.”


Some would call Bob Pavey a contrarian for his take on those heady, irrational days of the e-commerce boom. Was it really just last April that the Nasdaq was soaring past 5,000 and Munder’s NetNet funds were announcing they could no longer take on new investors?

There was method in that madness, says Pavey, a general partner at Morgenthaler Ventures of Menlo Park, Calif.

Pavey is a relative graybeard of the VC business who was has been taking high-tech companies public for more than two decades, going back to an IPO for an Ann Arbor, Mich., company named Comshare that was in demand because it leased time on mainframes.

To focus on the craziness and the excess of a year ago is to focus on the small picture, he says. Take the larger view: The frenzy and hype focused on e-commerce also focused attention on bandwidth, and how much of it would be needed.

And there is nothing illusory about the need for bandwidth, Pavey says. It is a very real problem that got everyone’s attention much sooner than it would have otherwise.

“My reaction is that e-commerce had to come first,” he says “That was what created the demand for bandwidth. And because of it, what’s going on now is that we are building infrastructure . . . it was e-commerce that created this tremendous demand for infrastructure.”

Pavey may also be considered contrarian by taking a kinder view of the current gold rush toward optical networking, what some have described as merely the latest manifestation of the VC herd mentality that poured money into e-commerce a year ago.

A lot of money is going into switching companies or technologies that are destined to fail, he says. But the problem of converting electrical switching systems to all optical will require a broad range of solutions and a combination of technologies, and no one knows what those will be.

It’s not so much another example of the herd mentality as it is fairly typical of the VC model over the years. The few home runs support a preponderance of failures, he says.


Pavey is about ready to close on the latest Morgenthaler fund, No. VII, some $750 million that will focus on funding young growth companies in the Internet-infrastructure sector. For comparison, its current fund, No. VI, is $570 million.

The newest fund continues a push in optical by Morgenthaler.

“We began investing in this space two years ago and we have 20 companies now. There are multiple technologies that will be used for switching,” says Pavey. “Each technology will have its space.”

Morgenthaler investments in the optical sector, thus far, include $75 million each for Innovance Networks and Lightwave Microsystems; $73 million for Terawave; $70 million for Agility; $60 million for LightChip; $37.5 million for Peregrine Semiconductor; $18 million for Zolo; $15 million for FONS; and $12.1 million in January for fiberSpace, a developer of high-performance laser sources that won’t even be in beta testing until the end of the year.

The crash in e-commerce in general, and the recent market quakes, aren’t all bad for VCs, either, says Pavey. “The e-valuations we saw in 1999 were attractive. By mid-2000, they were crazy. Now, they’re attractive again. We can negotiate much better deals now than we could have eight months ago.”

Does a free-falling Nasdaq cause him concern as he makes the rounds, trying to raise $750 million? Not as much as you’d think.

“It’s just normal. Things get crazy on both sides. A year ago, we were urging companies to spend faster or they would lose market share. Now we’re telling them to hold on to their cash.”


Nader Najafi, chief executive of ISSYS, Inc., a maker of biosensors in Ann Arbor, is happy the irrational days of e-fever are behind us.

Najafi recalls, for example, taking a business plan to a consultant two years ago. The first thing the consultant told him was that he’d have to speed up his projections. If Najafi hoped to find funding, the business plan needed to project an IPO in two years, not four, the consultant said.

“I said `No.’ The investors should be long-term investors,’ ” he says.

Warren Packard, a managing director at Draper Fisher Jurvetson, a Redwood City, Calif., VC with half-a-dozen MEMS and microsystems companies in its portfolio and whose current fund is $650 million, says Najafi was smart to go slower. And that remains good advice for entrepreneurs these days as those in the bio sector feel left behind by their counterparts in optical networking.

“There’s been a herd mentality to fund companies in a given space. It didn’t matter what they did, just that they were in a given space,” says Packard.

“A year and a half ago, it seemed you couldn’t lose money anytime you invested in e-commerce. About the time you think you can’t lose money, is about the time you will.”

The same thing, he fears, is happening in the rush to optical. “This is not the time to invest. It is a crowded space. It’s too late.

“Well, I shouldn’t say too late, because I don’t want to be negative, and there’s always room for someone carving out their own niche, but there are 50-some MEMS optical switching companies now. How many are going to be successful? Two or three? It’s not a market to get into.”

Draper Fisher has a strong position in optical, says Packard. “But we got in early. We got into BrightLink in ’98, for example. You’ve got to be in front of the herd mentality.”

A definite non-herd move was Draper Fisher’s recent investment, co-led with DynaFund, in an $11 million first-round investment in MEMGen, a MEMS fabricator in Los Angeles that focuses on non-traditional, non-silicon materials.


“MEMS, nanotechnology — some of this stuff that looks like science fiction — we’re taking a very hard look at,” says Packard, “The MEMS realm is just primed for an explosion in a number of areas.”

He sees MEMS-enabled devices helping people interface with the Internet, including medical sensing devices that send feedback on your health via the Web to your doctor.

“They’ll be macrodevices made up of microdevices,” he says. “It’s very difficult to visualize what these things will be, but we’ll be on to something very interesting. We’ll leave it up to the entrepreneurs to come to us with their vision.”

Another area of interest for Draper Fisher is Pittsburgh, where a Draper-affiliated fund called Draper Triangle is focusing on nanotechnology and MEMS, through activity in those arenas at Carnegie Mellon, the University of Pittsburgh and Penn State.

One of Draper Fisher’s principals, Tim Draper, recently said at a conference in Pittsburgh that the e-commerce collapse and market turmoil make this “my favorite time for investing. When the market goes way up, like it did, I get nervous . The Internet started out with big hype and then a big letdown. That’s when the real opportunities emerge.

“For the past three or four years, venture capital was seen as a way to help entrepreneurs make a quick million,” Draper says. “But venture capital is really about helping entrepreneurs who want to change the world. People are starting to realize that again.”


Tom Henderson at [email protected] or call 734-994-1106, ext. 233.

COVER PHOTO: Bob Pavey, a general partner at Morgenthaler Ventures of Menlo Park, Calif.


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