<http://www.nytimes.com/2004/05/15/technology/15venture.html?th=&pagewanted=print&position=> The New York Times May 15, 2004 Bring Us Your Small, Unloved Start-Ups By GARY RIVLIN ilicon Valley is littered with hundreds of former start-ups trapped inside larger technology companies that are no longer happy with the ventures they snapped up in the acquisitions frenzy of the 1990's. Now a pair of Silicon Valley-based venture capitalists have opened an unusual $250 million fund intended to buy and rehabilitate such companies, which Terry Garnett, one of the two founders, calls "the orphaned and the unloved." In some cases, the best candidate for running the newly freed company may turn out to be its original creator. "We've heard from a number of founders," Mr. Garnett said, "who told us, 'Gosh, we sold our business four years ago, and now our baby has been all screwed up and we want it back.' '' The new fund, called Garnett & Helfrich Capital, is expected to occupy a long-needed niche within the technology universe's constellation of venture partnerships and private equity groups. Other entities, like Francisco Partners and Silver Lake Partners, specialize in technology buyouts, but they usually focus on deals priced in the hundreds of millions. Garnett & Helfrich intends to concentrate on deals, generally under $50 million, too small for these multibillion-dollar firms. Traditional venture capital outfits occasionally participate in these kinds of deals, sometimes called carve-outs, but only sporadically and often in partnership with others. "There aren't a lot of venture guys doing tech carve-outs, and none are specializing in it," said Allan Thygesen, a managing director in the Carlyle Group's American-based venture capital fund. "It's sort of a forgotten area." Venture capitalists, Mr. Thygesen and others said, are by temperament far more interested in untested, fledgling companies that stir hopes of striking it rich with a new idea rather than those already freighted with baggage. Mr. Garnett was in his prior job as a general partner at Venrock Associates, the venture arm of the Rockefeller family, when he experienced what he described as his "aha" moment. Along with a partner from Doll Capital Management, he was poised to invest in a new software company that would cloak e-mail messages and instant messaging from everyone but the intended recipient. But then Mr. Garnett and his fellow venture capitalist learned that Network Associates, the computer security company, was looking to sell a unit called PGP, which stands for Pretty Good Privacy, with a similar product already on the market. PGP was a proven technology with a sizable customer base. It was also one of more than 40 companies Network Associates bought over three years starting in 1997 - and one of many acquisitions it was actively seeking to shed after hiring a new chief executive at the start of 2001. Venrock and Doll Capital purchased PGP in August 2002 for "significantly less" than the $36 million Network Associates paid for it five years earlier, said Phillip Dunkelberger, the company's original chief executive and once again in charge of PGP. "That was a real proof of concept for me," Mr. Garnett said. "We were able to recast the product and be cash-flow positive six months after buying it." In February 2003, Mr. Garnett and David Helfrich, then a general partner at ComVentures, met for breakfast at Il Fornaio, a popular restaurant in Palo Alto. The two knew each other casually but had grown closer through their daughters, who enjoyed riding horseback in Woodside, Calif. There Mr. Garnett told Mr. Helfrich about PGP. "I knew I was in trouble after I didn't sleep a wink that night," Mr. Helfrich said. Four months after that first breakfast, the two gave notice at their respective firms. That summer, Grove Street Advisors, which makes venture capital investments on behalf of large institutions and wealthy individuals, became the new fund's first investor. The fund's largest investor is the Harvard Management Company, the university's investment arm. "It's quite unique what the two of them are doing," said Catherine A. Crockett, a founder and general partner at Grove Street. The firm is expecting to do one or two deals a year, and six to eight for the life of the fund, because each will require a great deal of time. Mr. Garnett is a former senior executive at Oracle, the big maker of database software that runs large business systems for many major corporations. Mr. Helfrich was a member of the founding team at Copper Mountain Networks, a maker of equipment for high-speed Internet connections, and his risumi includes turns at the 3Com Corporation and Ascend Communications, two other computer networking equipment makers. Certainly the pool of potential orphans is large. From 1999 to 2001, an average of 3,500 mergers and acquisitions (excluding telecommunications deals) took place each year in the American technology community, according to Thomson Financial. That compares with roughly 500 a year in the early 1990's, and 1,500 or so a year in the mid-1990's. "I have absolutely no doubt these guys face a tremendous supply of deal opportunities," said Roger McNamee, a co-founder of Silver Lake Partners. Whether that will translate into attractive profits for the fund's two founders and its investors is another question. "There's typically a high degree of difficulty in these kind of deals," Mr. Thygesen of Carlyle said. Pricing is one issue, Mr. Thygesen said; typically there are no audited numbers associated with a single product or unit inside a larger company. "Another risk is that you're taking on people who haven't been out there hustling, groveling for a living," Mr. Thygesen said. "They're not necessarily entrepreneurs." Should an investment team choose well, though, "there's the potential for a very high value creation," he added. Both Mr. Garnett and Mr. Helfrich said that they intended in most cases to bring in new management to run the company and they see plenty of available executives in waiting. "Nowadays, it's hard to attract a great management team, especially a great C.E.O., to a start-up," Mr. Helfrich said. "It takes two or three years to get a product out, there are three or four rounds of financing to raise, and the success ratio of start-ups is pretty low." The companies they intend to finance, by contrast, will already have an existing business in place. "It's a lot easier to build a company from $50 million in revenues to $100 million,'' Mr. Helfrich said, "than take something from scratch and build it up to $10 million or $20 million." -- ----------------- R. A. Hettinga <mailto: rah@ibuc.com> The Internet Bearer Underwriting Corporation <http://www.ibuc.com/> 44 Farquhar Street, Boston, MA 02131 USA "... however it may deserve respect for its usefulness and antiquity, [predicting the end of the world] has not been found agreeable to experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'