Bring Us Your Small, Unloved Start-Ups

[R. A. Hettinga]

<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."


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R. A. Hettinga <mailto: rah at ibuc.com>
The Internet Bearer Underwriting Corporation <http://www.ibuc.com/>
44 Farquhar Street, Boston, MA 02131 USA
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