Fall 2001

Survival Strategies and Uncertain Times

Much has been written of course about the fall of the NASDAQ and associated debacles with "dot-gones" and "dot-bombs." We won't bore you with a recapitulation of this old news. But we will give you a sense of what we are seeing first hand in our own practice.

Many younger clients have sought some form of exit strategy involving a sale of the business or other arrangement. With the frigid equity financing markets, certain of these clients, and particularly internet companies, are seeking to preserve value for their investors. A few examples in our office include:

• The sale of a venture backed web-based investment advisory services start up to a more substantial European based company in the same space. The shareholders of the seller have received shares of the European buyer under this transaction. The European buyer has relied successfully on a client-server architecture in the delivery of its services. One of the strategic values of the U.S. company is its web-based technology and the knowledge and experience of its technical team in this area.
  
  
• The sale of a venture backed internet client in the educational space to a more established and profitable buyer in a similar space. In this particular transaction, earlier investors are not expected to receive anything as part of the merger. The value of the seller to the buyer is in its customer relationships, its people and its investors, who are investing in the buyer as part of the transaction.
  
  
• The transition of a client with certain web-based video products and technology from a product business to a technology licensing strategy. Due to its inability to raise capital to sustain the normal overhead of an operating company, this client has chosen to reduce overhead and try to payoff its liabilities and seek a return for its investors through licensing royalties.
  
  
• The transition of a web-based telephony client into more of a "hibernation" mode. As in the case described above, the purpose is to bring down the burn rate and to obtain modest bridge loans to enable the longer-term survival of the enterprise.
  
  

On a more positive note, clients that are profitable and/or well funded continue to move ahead in their business plans. Perhaps ironically, many of our clients that have pursued a more unorthodox funding strategy - offshore money, private placements, corporate alliances, etc. - may turn out to have a better chance at survival than venture backed start-ups. What are the reasons? We think that a major potential risk of being venture backed is the compelling force to move forward as quickly as possible, even when the product and the markets remain unclear and untested. Or to put it a slightly different way, the fact that non-venture capital backed companies may need to move forward in a more tentative way, making perhaps more but smaller mistakes (but hopefully also learning from them), can help them avoid a more tragic misstep.

There remains no shortage of start ups in our office, including somewhat surprisingly internet companies. If there is a common thread amongst these internet companies, we would say (with the significant benefit of hindsight) that they are focused on revenues and profits and no longer seem to be founded by young first time entrepreneurs. Instead, they are typically being founded by seasoned executives who have been successful in and are extremely knowledgeable about their respective business segments. They perceive the power of the internet, and rather than being entrepreneurs with a technology in search of a market, have a market and are in search of the most appropriate internet technology to solve a pervasive problem or inefficiency in that market.

We also have no shortage of new start-ups contemplating other technological and business innovations in such diverse fields as product design and engineering services, brain mapping, automated voice payment, and generic drugs, just to name a few. In general, we anticipate a much longer funding cycle, especially at the seed stage, and lower valuations than before.

During these uncertain times, it is also our understanding that there may also be a shake out in the offing even among venture capital funds. Those funds that, whether through smarts or luck, have been able to achieve solid returns are raising more and even larger funds. Those other funds - many of them newer - who don't have this advantage and who may have invested heavily in the dot coms may be struggling. Many funds are also currently fire fighting - reinvesting in their existing portfolio companies to keep them afloat. However, in the long term and given the billion dollar funds that are still being raised, we expect that the venture capital funds will need to get back into new investment in order to put their money to work. It is our belief that the companies with fundamental new technologies, experienced management teams, and innovative business strategies will still attract capital in the long run.

As the summer ebbs we look forward to an exciting fall. We intend to keep you posted on any new developments at our firm and in the entrepreneurial and legal marketplace in this section of our website.

We are living in interesting times.