NOTHING VENTURED : While Silicon Valley has no trouble drawing investors, the young companies of Orange and L.A. counties are suffering a capital crunch.
On a cool July evening, a spillover crowd of about 200 entrepreneurs gathered in Irvine with a common goal in mind: snaring enough investment dollars to turn their dreams into viable businesses.
Among them were engineers, operators of web sites and developers of medical devices. They nibbled on fruit and cheese and eagerly sopped up the collective wisdom imparted by Bay Area venture capitalists--do your homework, learn the idiosyncrasies of venture funds, get to know well-connected attorneys and accountants.
The reality is that if even one or two of them gets venture capital “it would be great,” said Jack Mixner, a management consultant who helped organize the event.
In Southern California, where nearly two-thirds of new businesses in the state are formed, young companies are going hungry, and what they lack is the very stuff on which their survival depends: money.
“There’s a generic, across-the-board lack of funding in Southern California,” said Fred Rogers, president of Select University Technologies Inc., a Newport Beach firm that turns university-based concepts into businesses.
It’s a little-seen but critical missing link in Southern California’s economy, experts say.
Certainly, the business climate has vastly improved. Orange County has low unemployment and thriving medical technology and electronics industries. Los Angeles, ravaged by aerospace cutbacks, is reviving thanks to healthy entertainment and foreign trade sectors.
Nonetheless, many believe the dearth of capital is hampering growth in the technology hubs of Irvine, Burbank-Glendale, Santa Monica and along the Los Angeles-Ventura County border. Frequently compared with Silicon Valley, these areas have yet to achieve anything near to the unbridled prosperity of the behemoth to the north.
When it comes to nurturing new, cutting-edge industries, “we’re just babies starting down the road,” Rogers said.
Venture capital firms are the most visible example. They raise money and invest it in young businesses in hopes of making a killing a few years later when the companies are sold or go public.
In 1996, these firms invested $446.4 million in companies in Los Angeles and Orange counties, while $2.3 billion went to Silicon Valley, according to the accounting firm Price Waterhouse.
Southern California has only about a dozen resident venture capital firms. A decade ago there were more than twice as many, but the recession prompted some to close, while bank-run funds fell victim to industry mergers. Many that remain are investing more in Silicon Valley, saying that’s where the action is.
In Northern California, there are about 150 venture funds, and the vast majority of their investments are close to home. Some have opened branch offices in Southern California in the past, only to close them because the number of deals didn’t justify the overhead.
Indeed, in all of Southern California, only the biotechnology community in San Diego has been a consistently strong recipient of venture capital funds.
“You could go to the southern tip of San Jose, hop on a plane and fly down to San Diego, and there’s not much going on in between,” said Rolf Selvig, director of business development at the San Francisco research firm VentureOne.
To be sure, venture capital isn’t the only way to finance a new business. Entrepreneurs still mortgage their houses, run up their credit cards and borrow from friends and family. But the death rate among such companies is high because they usually run out of cash before getting off the ground.
What’s more, high-tech, cutting-edge firms often require big capital infusions that only a wealthy investor or venture capital fund can provide.
“We know which ones have made it,” said James L. Watts, managing director of Pacific Summit Capital, a corporate finance boutique in Irvine. “But how many companies tried to raise money and had a good idea, and could have built it and thrived and grown and made a lot of jobs and paid a lot of taxes? We’ll never know.”
It’s a complex problem, and solutions won’t come easily, experts say. But the effect of Southern California’s capital crunch, many contend, is that few market-leading companies have emerged to replace the shrunken aerospace infrastructure.
For every high-tech success story in Southern California, such as Western Digital Corp. and Kingston Technology Corp., venture capitalists say they can name at least 10 in Silicon Valley.
“Hewlett-Packard is a $20-billion company,” said Bob Hoff, general partner at Crosspoint Venture Partners in Irvine. “That really brings stability to a region.”
The disparity is even more glaring considering that Silicon Valley has scores of leading companies packed into an area that spans no more than 30 miles in each direction from San Jose. Los Angeles and Orange counties form a huge region with more people than Illinois (12 million), more workers than Michigan (5 million), and a gross product bigger than that of 47 states ($354 billion).
Yet for all its vast resources, Southern California isn’t attracting the seed money needed to spawn the industries of the future, many business people contend.
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The capital shortage is particularly acute among very early stage companies, which usually need about $200,000 to $1 million in seed money. Nationally, venture capital funds have grown so flush with cash in the past few years that most are only interested in investments of $2 million or more.
The gap is typically filled by so-called “angel” investors--wealthy individuals who back start-ups. Those deals are hard to measure, but they can account for five times the investments made by venture capital funds, experts say.
Yet an active, well-organized angel community is also noticeably absent in Southern California.
“I see four or five companies a week that are at least serious contenders for money, but most are not getting funded,” said Brent Rider, former head of Union Bank’s now-defunct venture capital fund who now heads Marina Ventures, based in Pasadena and Huntington Beach.
Why is it so tough for Southern California entrepreneurs to get capital?
In large part, it’s because the region’s history hasn’t been one of entrepreneurs but of real estate, motion pictures and defense and aerospace.
Real estate money generally hasn’t gone into high-tech ventures. The entertainment business tends to be an insular community that has found investors from within its own ranks, and recently from foreign concerns.
That leaves defense, which at first glance might seem a natural spawning ground for high-tech offshoots. In the 1980s, the best and brightest kids coming out of universities were snapped up by military contractors. When the industry collapsed, thousands of them were unleashed, and some have started their own ventures.
But most have found it rough going trying to raise money. Venture capitalists say that’s because the engineers, programmers, scientists and executives from the world of government contracting are ill-prepared for the fast-paced commercial arena.
“All those people who grew up in defense and aerospace never learned anything about marketing, and never learned anything about leadership,” said Jim Cole, general partner of Spectra Enterprise Associates in Westlake Village.
“They’re not fast and loose guys who know how to make their own coffee and sweep up at night,” said Ken Deemer, a private investor and partner at InterVen Partners in Los Angeles.
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Southern California also suffers simply by contrast to the star in the north.
It’s not an entirely fair contest. While Southern California’s aerospace machine was in high gear, Silicon Valley was becoming a unique convergence of investors, academics and professionals.
Stanford University, for instance, played an active role in the birth of giants such as Hewlett-Packard Co. These concerns bred the next generation of hot companies. From those, more spinoffs emerged.
Silicon Valley is now a well-oiled network, where deals are handed to venture capitalists complete with experienced management teams, banking relationships, well-crafted business plans and marketing strategies.
“A lot of the deals in the Bay Area come to the venture capital firms with a nice neat bow tied around them,” said Chuck Martin, general partner of Enterprise Partners in Newport Beach.
Not so in Southern California, where venture capitalists say entrepreneurs lack the savvy of their northern counterparts.
For that reason, even some local venture capital firms, like Los Angeles-based Brentwood Venture Capital, are turning their sights northward.
Brentwood is one of the area’s largest and best-known venture capital firms. But in the past year, Brentwood has made just four investments in Southern California, and about four times as many in Northern California.
“It’s not that we’re discriminating,” said general partner Dave Chonette. “We’re looking at what’s available.”
Some observers, like Rohit Shukla, chief executive of the nonprofit Los Angeles Regional Technology Alliance, complain that most venture capitalists don’t understand Southern California’s diverse economy, and its different breed of entrepreneur. They think the answer is more home-grown venture capital funds staffed by experts in the local marketplace.
Others believe that’s putting the cart before the horse.
“You could put all the money in the world here,” said Bob Hoff, general partner of Crosspoint Venture Partners in Irvine. “But if the quality deal flow and people aren’t here, then you’re just going to fund a lot of bad companies.”
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Many venture capitalists argue that Southern California must first develop an infrastructure that includes effective university outreach programs, high-tech incubator projects, and a network of lawyers, accountants, bankers and others with expertise in early stage financing.
Most important, they say, is cultivating a reservoir of leadership talent--experienced top executives willing to throw in with young entrepreneurs.
There are signs that such changes are afoot.
Organizations such as the Orange County Business Council, Los Angeles Venture Assn., the Irvine Co., and UC Irvine’s Accelerate program are trying to jump-start a community of professionals and investors to help entrepreneurs.
More encouraging is that a few local venture capital firms say they’re finding plenty of opportunities at home.
“We see more than 2,000 quality deals per year, and that number is growing pretty strongly,” said Harry Lambert, a general partner at Costa Mesa-based Innocal.
Funded by the California State Teachers Retirement System, Innocal has 13 of its 19 investments in Southern California companies. Enterprise has 85% of its investments in Los Angeles, Orange and San Diego counties.
What’s more, as venture capital funds continue to bulge with cash, and as Silicon Valley grows increasingly congested, Bay Area firms will have to cast bigger nets, many believe.
Stephen L. Shirley tried for years to convince Hambrecht & Quist, one of the biggest and most powerful Bay Area venture capital firms, to open an office here. For years, the answer was no.
Finally, Shirley got the green light and in March the former Kidder, Peabody & Co. managing director opened Hambrecht & Quist’s Newport Beach office. “There’s a huge opportunity down here for us,” he said.
Ultimately, many believe, Southern California’s entrepreneurial success--and economic well-being--will come down to a buck-stops-here mentality.
That requires shedding the last vestiges of the region’s aerospace-dependent past, they say. It means welcoming and encouraging those who would leave comfortable jobs for a warehouse cubicle with dim lights and folding chairs.
Some investors say that’s already happening, and the proof will surface in about 20 years’ time. “There is such a tremendous vitality here,” Rider said.
“I’m seeing a number of quality deals, many of which are not getting done,” he said. “These could be companies that give tremendous value to the community, which could find the cure for Alzheimer’s disease.
“If we had the money, things would be happening.”
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What Is Venture Capital?
Money invested in new and rapidly growing companies-- usually those with the potential to become nationally or internationally prominent. Investment amounts are large, usually more than $1 million.
Who Are the Investors?
* Partnerships of individuals specializing in private-equity investing. These groups pool their own money, money from wealthy individuals, and that of institutional investors such as pension funds for distribution to high-risk emerging growth companies. In exchange, the venture capital firms receive equity in the company and play an active role in the fledgling firm’s growth and development. Venture capitalists have a long-term orientation and take higher risks, expecting higher rewards. Most venture capital firms specialize in a particular industry, such as biotechnology, medical devices, software, hardware, communications and the Internet.
Receiving a Big Boost
Companies in which venture capital investment played a vital role:
* Federal Express
* Boston Market
* Genentech&
* Gymboree
* Netscape Communications
* America Online
* Intuit
* Apple Computer
Capital Distribution
Silicon Valley receives 75% of the venture capital in California and 24% of venture capital distributed nationwide. How venture capital was distributed in 1996 in four regions of California and how these regions compare with the top five U.S. venture capital markets (dollar amounts in millions):
California
Silicon Valley
75% of total
$2,298.3
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Los Angeles / Orange County
15% of total
$446.4
*
San Diego County
10% of total
$316.9
*
Sacramento / Northeastern California
Less than 1% of total
$15.2
United States
1. Silicon Valley
24% of total
$2,298.3
*
2. New England
13% of total
$1,2741
*
3. Southeast
11% of total
$1,081.2
*
4. Midwest
9% of total
$895.8
*
5. Texas
7% of total
$668.9
*
5. New York metropolitan
7% of total
$662.5
*
6. Los Angeles / Orange County
5% of total
$446.4
*
10. San Diego County
4% of total
$316.9
*
17. Sacramento / Northeastern California
Less than 1% of total
$15.2
Totals may not equal 100% due to rounding
Source: Price Waterhouse LLP
Venture Capital Center
Silicon Valley is home to more than 100 venture capital firms. In fact, so many are located along Sand Hill Road in Menlo Park that the street is becoming an industry symbol. California venture capital firms, by region:
Silicon Valley: 114
Los Angeles / Orange County: 34
San Diego County: 12
Sacramento / Northeastern California: 2
Investment Stages
Companies typically seek venture capital investment at one or more of these developmental stages:
* Seed financing: Money for developing a business plan or concept
* Start-up: Money for product development
* First-stage: Entrepreneur typically has a prototype and is ready to begin manufacturing
* Second-stage: Company is shipping its product but is still not profitable. Venture capital investment is needed to sustain the operations.
* Mezzanine financing. Funds provided for major expansion of a company that is generating increased sales and is breaking even or turning a profit. Funds used for further plant expansion, marketing, working capital or development of an improved product.
* Bridge financing. Funds carry the company through to a public stock offering, or to merger or acquisition by another firm.
* Restart: The product or marketing focus of a company is undergoing substantial change.
Sources: Price Waterhouse LLP, VentureOne Corp., National Venture Capital Assn.; Researched by JANICE L. JONES / Los Angeles Times
