May’s cover story for business-technology magazine Red Herring asked the question “Who Wants to Be a Venture Capitalist?” Lured by the huge returns and the “record first-day pops” that turned the formerly obscure IPO marketplace into Main Street news, everyone from dorm-room entrepreneurs to ex-professional football players to Global 500 corporations seems to be jumping headfirst into the VC business. We recently talked to Seth Neiman, Managing Partner at Crosspoint Venture Partners of Woodside, CA (lead investors in Ariba, Brocade, and Covad), to get his advice on the role of venture capital in the current Net market and in new-business creation.
We wanted to know: What are the philosophies and investing strategies that enable VC firms to stay on top in a complex and competitive marketplace? Where is the Internet economy heading over the next few years? What trends do CEOs, CIOs, and investors need to understand?
We asked Neiman to discuss the developments that will move this economy—and its technologies—during the next few years.
TechRepublic: Let’s start with an overview of Crosspoint, and then let’s talk about your particular interests and specialties.
Neiman: The firm is 30 years old. We have six investing partners. We have a little over $2 billion under active management; we are well known for very early stage incubation, seed, and first-round investing, and in particular, in the communication space. We were chosen by Forbes earlier this year as the number one venture-capital firm worldwide based on actual returns.
What we try to do is to build dominant new companies in brand-new markets. We’re not interested in the quick-flip IPO candy, or as (Crosspoint founding partner) John Mumford likes to call them, “frou-frou.com.” In particular, we’re not interested in anything that can’t be a very large business that produces substantial value for its customers.
The tendency is to focus on deep-technology businesses—businesses that sell to other businesses. That shows up in a lot of ways. In that long list of our companies that made up the bulk of the top 10 IPOs in the last year, there’s a large number of incubations. Brocade was incubated in this office. So was Ariba. That really gives you a flavor for how we think about this.
In this installment, Seth Neiman, managing partner for Crosspoint Venture Partners, discusses how his company decides to fund businesses, the shakeout of the dot-com market, and the opportunities that Internet companies still have. In part two, he talks about changing service-provider models, the online storage industry, and business creation.
TechRepublic: That’s where an Ariba might fit in.
Neiman: That’s right, an Ariba or a Covad. Along the way you run into some wonderful serendipity like Brocade, where we saw the opportunity for a storage area networking technology to emerge, and through a lot of hard work, a lot of good luck, and just unbelievable execution by the company, it ended up presiding over the founding of a whole industry.
TechRepublic: You’re not looking for the little niche that somebody can come in and grab and make a quick hit.
Neiman: There’s investing and the financial piece of this, then there’s new-business creation and the trends in the market. A lot of people try to play it safe with a straight-line trend, and that just doesn’t work from our point of view. We’ve seen the period where the Internet was painted with one brush—one day it’s great, the next day it’s terrible—so we’re at the point where we ask, ‘Is it time to be doubters?’ I don’t think any deep-thinking person would accept that.
TechRepublic: Is it the role of venture capital to participate in that “try anything” process to see what really shakes out and what ultimately brings value?
Neiman: Absolutely, and I would take it a step further. There is no other institution that can do it. What’s happened is that we’ve had this wide reinvention that requires that new-business creation become a dominant force in the economy. One interesting thing that a lot of people have focused on recently is the rise and fall of the “dot bombs,” as they have been affectionately labeled. One of the natural things is that as consumers got attached to the Internet, marketing and selling to consumers would get attached to the Internet, and so every basic version of that has been tried.
E-tailing was never going to be a high-margin, high-growth business. Retail is a low-margin, difficult business, and it doesn’t turn into a high-margin business because you go to the Internet. That doesn’t mean that great new [retail] businesses can’t be created. Amazon, for example, is a terrific company. But it doesn’t become any different than bookselling. It’s just next-generation bookselling, with greater reach and greater opportunity to extend its brand than a brick-and-mortar company.
TechRepublic: And it has the opportunity to do some unique things that a brick-and-mortar company can’t do, like turning a product into a service.
Neiman: Exactly. There are all kinds of tricks, and some of them add value, but at the root, the business, although different, remains fundamentally the same.
TechRepublic: To become an engine of equity for new-business generation.
Neiman: I think that that would be giving them a little too much credit. What it was was that they could not stand aside. In the old days, five years ago, a large financial institution on Wall Street took risks in small-cap stocks by investing in small, solid companies with a linear growth and profitability. They bought their stock with the hope that they’d get large.
What has happened with the reinvention of the Internet is that the same institutions extended their risk profile to invest in companies without revenues, proven markets, or business models. That’s a very different game. The reason they did it was not because they were seeing deeply, but because the whole society was interested in it, and if you were managing one of those portfolios you’d get up at three o’clock in the morning and go, “What happens if I don’t get my fair share of this?”
TechRepublic: If I miss this I’m dead!
Neiman: Bingo! Because ultimately, new business creation is about markets functioning. A lot of the companies didn’t make it across the threshold, so we have this fallout that we’re sort of in the middle of.
TechRepublic: So this fallout is a natural and healthy part of the new business creation process?
Neiman: It absolutely is. We’ve come through this period and created some unbelievable companies, and the system is learning how to correct [its mistakes], how venture capital and private equity create even more and better opportunities, and how the public markets [can] be a little more selective and still get their fair share of the big winners.
With venture-capital companies taking a harder look at dot coms, what strategies do you use to convince them to fund your business? Share your strategies with us in an e-mail or post your comments in a discussion.