Valley: Still No. 1
January 30, 2006
Silicon Valley isn’t the only ecosystem of innovation
anymore, if it ever was. But it’s still the richest patch
of talent, ideas, and money around.
Silicon Valley CEO Max Seybold sits in the passenger seat of a
slate-blue 1972 Ferrari 365 GTC/4 and laughs as Edward Holl kicks
the V-12 engine up to 4,000 rpms and blows past a Corolla at double
the posted speed limit.
“Now we have success—so why can’t we enjoy it?”
he shouts over the roar.
Mr. Seybold runs Fox Technologies, an identity and access management
startup. His company rented a brace of Ferraris just to let investors
and executives have a spin in something fast at a Fox Tech open
house. The startup, which raised a $5.3-million round last year,
just moved its headquarters from Herndon, Virginia, and from Sweden
before that, to Palo Alto, California—the heart of Silicon
Every high-tech executive has heard how globalization is changing
business: off-shoring development to India, or targeting China’s
market potential, or tapping into innovation in Eastern Europe or
somewhere else. But for all that has changed since the dot-com and
tech crash, three things have kept Silicon Valley behind the wheel
of innovation and small-company growth.
It’s where the money is, it’s where the people are,
and it’s where the laws are written to accelerate innovation.
It’s a mix that has defined three big booms and may still
power another. Startups still flock to the San Francisco Bay Area
to put the pedal to the metal (see The Valley: New Blood).
Still on Top
Start with money. California remains the king in venture capital—the
San Francisco Bay Area alone attracted $2.03 billion in VC funding
during the third quarter of 2005, according to VentureOne. No other
region, no matter what locals elsewhere may do to promote investment,
can compare. New York City drew $303.4 million in that time, Israel
$311 million, and all of Europe only $890 million (see The Valley:
That said, investors now venture outside the Valley, looking to
cash in on success stories like Luxembourg’s Skype and China’s
Granite Global Ventures sent half of its VC team to China and kept
half in Silicon Valley, the China half getting behind companies
like e-commerce site Alibaba.com and Sino-blogging site Bokee.com.
Founded in 2000, Granite is now investing a $225-million second
fund and setting aside about 30 percent of it for targeting Chinese
technology companies. Director Scott Bonham says the trick to investing
globally is in understanding locals. You can’t just take your
Internet perspective and ram through another culture, he says.
Draper Fisher Jurvetson has partnered with 17 firms across five
different countries—all part of what it calls its “affiliate
network” giving Draper access to globally diversified deal
flow. Its Beijing-based ePlanet Ventures affiliate helped it capture
a quarter stake in Chinese search firm Baidu. Remember how its share
price jumped 353 percent on its first day of trading? Draper’s
stake is now worth $400 million.
In exchange for deal opportunities, Draper lends its name and Rolodex
to affiliates, and it may expand this happy arrangement and extend
its network even further. Indeed, Tim Draper has revealed that he’s
taking his firm to India with a $200-million fund.
The Syndicated Approach
Some firms employ a variation on the Draper strategy and partner
with foreign firms in syndicated deals. Perelgen Sciences’
monster $74-million fourth round earlier this year is an example
of such a deal. Perelgen sponged up cash from Biofronteir Partners
in Tokyo, Ultreia Capital in Zurich, Vulcan Ventures in Seattle,
and Zesiger Capital in New York City.
A4Vision, a biometrics company specializing in facial recognition
technology, corralled investors from all over, too: Menlo Ventures,
based in Menlo Park, California; MyQube, based in Milan; and Upstream
Ventures, based in Singapore.
Global syndication plays an important role even in small, early-stage
deals, such as the $5-million first round that Orlando-based business
intelligence software startup Pentaho collected from New Enterprise
Associates in Menlo Park and Index Ventures in Geneva.
Valley VCs have to think more about partnering with Europeans and
Asians on their investments, says Eric Buatois of Sofinnova Ventures.
“[But] syndication isn’t something you can do over breakfast
at Il Fornaio,” he says, referring to the popular Palo Alto
While syndicating is a more complicated, time-consuming process,
offshore investors don’t seem to need much convincing these
days, eager as many are to partner with valley venture. The trend
suggests a new niche for analysts: No one as yet appears to track
trans-national VC flows into high-tech startups, be that overseas
investors funding U.S. companies or Americans and other nationals
investing in Indian companies.
Anders Lindqvist, a VC with Stockholm-based IT Provider who took
in the Fox Tech open house, says he really came to Palo Alto to
look for VCs to partner with on his next deal. Technological innovation
comes easy to Europeans, he says, but capitalizing on it doesn’t.
“We have no Larry Ellisons in Sweden” (see The Valley:
Local Investments, Global Results
But many investors remain wary of straying far from their home,
especially when it comes to backing early-stage startups. Kleiner
Perkins Caufield & Byers, for instance, mentions only five foreign
investments out of 200 listed on its web site. Explaining why his
Woodside Fund has yet to venture into India or China, Managing Director
John Occhipinti says simply, “Our model doesn’t scale
What’s the worry? For one VC, it’s the problem of everyone
staying on the same page. Clint Chao of Formative Ventures remembers
how, when he worked at San Jose-based semiconductor company C-Cube,
development was spread across three buildings. “Communication
was tough then,” he says. “Expanding that out across
different countries poses a whole new level of complexity.”
That logic would rule out multinationals, or any company with offshore
branch offices for that matter—startups included. Consider
Fox Technologies, which hired 30 new salespeople in Silicon Valley
to handle its U.S. sales, some 50 percent of its business. “People
will come to where the customers are,” says M.R. Rangaswami,
the head of angel investing firm Sand Hill Group. “And that’s
still the U.S.”
Israeli developers know the problem. “If you walk out of
your door, and you’re an Israeli tech company, there’s
not a market for 1,000 miles,” says Jefferies Broadview Chairman
Paul Deninger. The solution that evolved came to be known as the
Israeli Model—keeping research at home and putting sales and
marketing operations in the United States.
Startups in other countries are following suit. Indian Wi-Fi security
developer AirTight Networks started out in 2002 as Wibhu Technology
in Pune, a short hop from Mumbai. It moved its corporate headquarters
to Mountain View, California, but co-founders Pravin Bhagwat and
Kiran Deshpande stayed behind with the research arm, building on
technology originally developed at the Indian Institute of Technology.
“VCs wanted a valley-based CEO,” explains Vice President
Jai Rawat, the first to staff the startup’s U.S. office. But
things changed fast after AirTight hired David King, the former
chief executive at networking company Proxim, as CEO. The company
quickly raised $10.25 million from VCs. “We immediately got
oversubscribed,” says Mr. Rawat. AirTight has since raised
another $12 million from Walden International, Trident Capital,
Granite Ventures, Siemens Venture Capital, and Blueprint Ventures.
It employs 120 people, 90 of them still based in India.
San Francisco-based Soma Networks, on the other hand, sells its
wireless devices for delivering broadband Internet into homes, and
its biggest markets are in China–yet it chose to stay in California.
“The angel investors were from Silicon Valley,” explains
Chief Operating Officer Greg Caltabiano. “They understood
the technology—if we had started somewhere else in America,
it would have been tougher to bootstrap up through this network.”
Facing Overseas Obstacles
Starting overseas wasn’t even worth thinking about. But local
VCs found they could take the company only so far. “When it
came time to expand, the ones who really understood the market and
understood how big it was going to be were investors in Asia,”
says Mr. Caltabiano. The company hooked up with Temasek Holdings,
the Singapore government’s huge investment company, which
made a recent $50-million investment.
Lenovo’s $1.25-billion acquisition of IBM’s PC business
last year precipitated a rapid globalization push for startups selling
to the computer giant. Take UPEK, a startup that makes a biometric
finger scanner for IBM ThinkPads. Originally spun off of STMicroelectronics,
a Swiss company, UPEK maintains a third of its work force in the
Czech Republic, even though design on its main product is done in
Berkeley, California, where another third work. The rest live in
Asia, where manufacturing and sales happen—production at the
company’s Singapore original equipment manufacturer, and sales
in China (Lenovo) and Japan (Sony).
The biggest obstacle overseas was hiring top-notch people, according
to Marketing Director Greg Goelz. He wanted to keep the sales team
local, but locals weren’t interested in working for an unknown,
he says. The solution was to hire recruiters who helped build up
recognition for the brand and then got the right people—but
they came at a cost.
A startup’s success depends as much on nailing markets as
anything else. When it comes to mobile technology or consumer electronics,
the U.S.—the Valley, in other words—places last for
Jean Schmitt, a managing partner at Paris-based VC firm Sofinnova
Partners. “I tell my companies to first go to Asia, then develop
Europe and go into the U.S. eventually,” he says.
He cites the success of Esmertec, a Swiss company that makes software
for mobile phones and embedded devices, which went public in 2005
with revenues of around $250 million. Two-thirds of its employees
are in Asia, the rest are largely split between Switzerland and
Britain. One small team is located in the U.S.
Another European, Anne Glover, co-founder and chief executive of
Cambridge-based Amadeus Capital Partners, has no doubt about Europe’s
lead over everyone in mobile. “We have in this ecosystem all
the thought leaders on how this industry is going to evolve,”
Isn’t that what people in the Valley always said about the
personal computer and the Internet? Well, irony of ironies, Europe
and Asia both lead the U.S. in broadband to the home, the high-speed
connections that are supposed to drive PC and Internet use—and
subscriptions are growing faster than they are in the U.S. Asia’s
consumer markets are also growing like gangbusters, another reason
the Valley is starting to look out, instead of in.
Indeed, Esmertec’s success again challenges the notion that
Silicon Valley somehow holds an exclusive patent on entrepreneurial
networking—or that any ecosystem outside of the Valley is
somehow dysfunctional. The company was funded by French, German,
and Swiss VCs, its board is entirely European, and when it went
public (in Switzerland) its management was entirely European. “This
just goes to show that we can create multi-million dollar companies
in three years with people from Old Europe,” says Mr. Schmitt.
(For a look at Silicon Valley networking, see The Valley: Networking).
Changing Times and Rules
It’s easy to take Silicon Valley’s legal structure
for granted. There’s a clear framework for making investments,
a mature stock market, and plenty of protection for intellectual
property. Countries such as China, on the other hand, are still
trying to sort out these basics. Venture capital investment there
dropped 16.7 percent in 2005 to a little over $1 billion, according
to Zero2IPO. Analysts blame the decline on new regulations hamstringing
Chinese partners and companies registering offshore.
There are cultural issues, as well. About 90 percent of VC exits
are through acquisitions, trade sales being the lifeblood of the
venture industry. Yet Chinese don’t look at a sale as a success,
says Brewer Stone, an investment banker with East Peak Advisors,
based in Greenbrae, California. “Here if you say your company
was bought by Cisco, you hear congratulations,” he says. “That’s
probably not what people would say over there.”
But that’s changing, as even Mr. Stone concedes. Yahoo’s
acquisition of 3721, for instance, sold at 70 to 120 times its annual
revenue. “It was widely considered to be a good deal for the
seller,” says Mr. Stone. Then there was Yahoo’s move
on Alibaba. No one says the $4-billion payout was a bad deal for
CEO Jack Ma.
“Government regulation is the meteor that has hit our economy,”
observes VC Gary Morgenthaler. Sarbanes-Oxley reforms tightened
the framework for fair disclosure and reporting of U.S. listed companies,
cutting into corporate profits and keeping stock prices down. More
important from a VC perspective, it raised costs, raising the price
of admission to, and trading on, public exchanges. Small public
companies might pay $250,000 a year on compliance, large corporations
up to $35 million. “The requirements for going public are
very clear,” says 3i investor Sandy Miller. “Growing,
profitable companies do well in the public market.” Sarbanes-Oxley
makes earning a profit a lot harder.
The Federal Policy Factor
Cashing in on effort also got tougher when the U.S. Financial Accounting
Standards Board required stock options to be expensed on a company’s
income statements, again cutting into earnings.
Silicon Valley lobbied hard against this measure, many firms having
relied on the promise of future stock options to keep salaries down
and their burn rates low, thus contributing to growth. In July,
the U.S. House of Representatives voted to overrule Standards Board
on option expensing, but the bill stalled in the Senate.
“Stock option expensing is a disaster and will perhaps harm
us irreparably from an economic point of view,” says Jefferies
Broadview’s Mr. Deninger. “We’re going the way
of Europe,” he adds, letting his brand of raging sarcasm take
over. “I got a great idea—let’s let India and
China model their economic markets after the U.S. in the ’80s
and ’90s, and let’s model our markets on the zero-growth
economies of Europe.
“Who came up with that brilliant idea?”
Cuts in federal research grants and science programs are a worry,
too—2006 will be the first year that the National Institutes
of Health has its budget cut in 36 years, according to the American
Association for the Advancement of Science. Tighter immigration
quotas are another concern, as foreign engineers educated in the
U.S. ship out. Transportation and communications infrastructure
are also stretched to the breaking point.
This has some investors panicked. “Mayday!” Carlyle
Group’s Bob Grady calls out. “We have a problem.”
Policy makers seem unaware of how their decisions are affecting
startups and the innovation economy, he contends. “The venture
community needs to sound the alarm.”
Mr. Grady will be doing some alarm ringing in an official capacity
beginning in May when he officially moves in as president of the
National Venture Capital Association.
Although Silicon Valley isn’t the bed of roses it once seemed
to be, it still has the most fertile ground for startups to grow.