On Silicon Valley's Sand Hill Road, the Wall Street of the venture capital industry, there is no panic.

The steep drop last week in the price of technology stocks, punctuating a three-week slide, may mark a turning point in perceptions. Unless the technology shares rebound quickly, the Internet industry will no longer be seen as a sure thing for investors and entrepreneurs hoping to cash in quickly.

A few bad days were one thing. But with the shares of many leading technology companies now down by 40 percent or 50 percent in less than a month, the sell-off is causing anxiety across the New Economy -- even if many experts predict that Internet technology will continue its inexorable expansion into virtually all parts of the old economy.

Reuters
 Trading in futures contracts on the Nasdaq 100 index at the Chicago Mercantile Exchange reached frantic levels on Friday afternoon as the session neared its end.

The anxious include students at the Harvard Business School. Last year's graduates plunged with abandon into the Internet revolution, especially those who helped found 35 start-up companies including Guru.com, UBUBU.com and eFrenzy.com. This spring, the Harvard business class of 2000 seemed to be heading for a similar number of start-ups and perhaps a few more -- until last week.

"The students are scared to death," William A. Sahlman, a professor at the business school, said last Friday. "The free fall in the stock market this week shook their confidence and caused people to reassess their career plans."
Sahlman, co-chairman of Harvard's entrepreneurial studies program, noted that three groups of worried students considering start-ups had visited him in recent days, seeking his advice. "Right now, I'd say we'll have half the number of start-ups out of this year's class, compared with last year," he said. "And that's probably not a bad thing."

The long-predicted winnowing of dot-com companies now seems at hand, according to venture capitalists, industry executives and economists. The term "Internet" in a business plan, they say, will no longer assure funding for a start-up or a quick welcome in the stock market.
Yet a more sober investment environment, they add, is not likely to slow the development or spread of Internet technology across the economy. The Internet, they point out, is a low-cost communications network that promises to curb inflation over the next decade, lift productivity and enhance the efficiency of business throughout the economy -- benefits, they say, that will be as valuable when the stock market opens Monday morning as they were a week, a month or a year ago.

The underlying trend, though, may provide scant comfort for investors. Fundamental technologies in the past -- railroads, electricity and automobiles -- have been marked by investment euphoria, waves of start-ups, fierce competition and harrowing industry shakeouts.
An investment mania in Britain in the 1840s helped build that nation's railway system, but it eventually left a trail of corporate bankruptcies. From 1900 to 1925, there were more than 3,000 automobile start-ups in the United States turning out all manner of cars -- from three-wheel models to ones steered by tillers like those on ships.
 

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And today's technology investors have no assurance that the worst is over. Technology share prices have dropped sharply recently, but they are still far higher than other sectors. As of Friday's close, the ratio of the stock price to expected earnings for the 72 information technology companies in the Standard & Poor's 500-stock index was over 41. That was nearly twice the level for the S&P 500 index as a whole.
"Maybe technology stocks are still overvalued by 25 percent or 50 percent or more; only the stock market can give us that answer," said Richard Shaffer, principal of Technologic Partners, a research firm. "But that fundamental shift of business onto the Internet in the last few years is a direction that is here to stay for years to come."

On Silicon Valley's Sand Hill Road, the Wall Street of the venture capital industry, there is no panic.
But there is the view among venture-capital veterans that another industry cycle may well be beginning -- as occurred in 1983, after the shares of personal-computer companies swooned, and in 1987, after the stock-market collapse in October, when the money pouring into venture funds slowed.

Such a prospect means that fledgling Internet start-ups without profits may no longer be welcomed on Wall Street only a year or two after they were founded.
So venture capitalists -- who supply early funding to start-up companies in return for an ownership stake in them -- may be taking a more back-to-basics approach in the future. Venture capitalists may begin picking fewer companies to back and nurturing them longer to maturity, before they try to sell shares to the public in initial public offerings.

Longtime venture capitalists say this more measured approach would be a positive development, even if it would also mean waiting longer to cash in. Instead of investing $20 million in a start-up that goes public a year later, they might have to invest $100 million over three or four years in a new company before selling its shares to the public. And they may have to be ready to pull the plug on less promising start-ups.

"A lot of the recent crop of dot-com companies will go under, and others will be sent to the fat farm," Michael Moritz, a partner in the venture-capital firm Sequoia Capital, said. "But it's a tonic -- however painful its administration may be for some -- that is pretty healthy."

Investors in venture-capital funds -- each of which typically backs many companies -- normally have their money tied up for five years or more. The funds are open only to wealthy individuals and institutional investors, not to Main Street stock pickers. The perspective of venture investors is a world apart from that of day traders. So it would take time before a lasting reversal on Wall Street affected the way business is done in the private venture-capital industry.

In 1999, venture-capital funds in the United States raised $46.5 billion, up from $27.9 billion the year before. The surge in venture money actually invested in companies was even more striking -- to $48.3 billion last year from $19.2 billion in 1998.
Until now, the rate of venture investment has accelerated further. In the last 30 days, there were 670 new venture-capital investments totaling $10.2 billion, or a rate of roughly $2 billion a week, reports VentureWire.com, which tracks the industry.

Yet as the technology-stock euphoria fades, venture capitalists say they expect the flood of money into venture funds to ease off. And if there is a lasting slowdown in Wall Street's enthusiasm for high-technology share offerings, then there could be an end to the stratospheric annual returns that some funds have racked up by taking companies public quickly and reinvesting in still more start-ups.

Over the years, the average annual returns of leading venture-capital funds have been in the 20-percent range, compared with the 100 percent or more that some have enjoyed in the last year or two.
Experienced venture capitalists have long recognized that a return to earth in technology companies was inevitable. But as investors who have benefited enormously from the run-up, they have mixed feelings about the recent steep falloff.
"I'm torn," said John Shoch, a partner in Alloy Ventures. "Sure, it's healthy to take the froth out of the market. But at the same time, we have four or five companies that are lined up to go public over the next few months."
Several Internet companies including Alta Vista, the Web directory and search site, have already postponed their plans to sell shares to the public.

Still, turmoil in the stock market does not mean that venture-capital funding will dry up. Even at the end of last week, some companies went public.
One of the start-ups that Shoch's firm funded, Nuance Communications, went public last Thursday. Its offering price of $17 a share nearly doubled on the first day of trading, closing at just under $34 a share. On Friday, when technology stocks plummeted, Nuance rose slightly to close at $34.3125 a share.
Nuance, based in Menlo Park, Calif., has developed technology for making voice-recognition software work more efficiently. It is a promising technology, since new companies are trying to make human voices and telephones -- not computer keyboards -- the main means of access to the Internet. At the same time, old-economy companies like banks and telephone companies hope to use the technology to further automate their customer-service operations.
"The environment is going to get more challenging," Shoch said. "But real companies with real technology and real businesses will get funded -- rest assured."

Such start-ups, venture capitalists say, will attract funds, because investors are willing to bet that they are promising companies making technological building blocks for the Internet economy, and thus are poised for strong growth.

The big shakeout among dot-com companies is expected to be among the consumer Web sites and services that raced -- and spent heavily -- to establish themselves as Internet brand names, especially over the last year or so. In selected market niches, they have all tried to be the "next Amazon," and most, of course, will fail.
The economic impact of the winnowing will likely be healthy. As one venture capitalist noted: "It will mean we have two or three Web sites selling pet supplies instead of seven. That's hardly a loss."

That Darwinian process is familiar to many. In the early 1980s, for example, there was a surge of investment in companies in the PC industry, which ended abruptly in the summer of 1983 when the market in technology stocks collapsed. Companies with now-forgotten names like Eagle Computer, Northstar Computer, Kaypro, Word Star, Vector Graphics, Priam and Miniscribe fell by the wayside during the shakeout that followed.
"But out of each one of these cycles of investment frenzy and turmoil, a handful of tremendous companies have emerged -- Microsoft, Dell, Sun Microsystems, Cisco, Oracle and others," Moritz of Sequoia Capital observed. "And the same thing will happen this time."

The focus of venture-capital investments in the Internet has already shifted from businesses that sell things directly to consumers to businesses that enable other businesses to work more efficiently. The so-called business-to-business market has long been regarded as the largest -- and most economically significant -- market for Internet technology.

As a low-cost communications network linking businesses worldwide, the Internet is expected to reduce the cost of buying materials, managing inventories and developing new products.
The Internet's impact in overhauling this "back office" of the global economy is uncertain and is just beginning. But most economists believe it will make a notable impact over time, just as electricity only made a big difference to industry when factories were reorganized for mass production. A recent study by the Goldman Sachs investment firm concluded that business-to-business electronic commerce could reduce average prices across the economies of the five richest nations by nearly 4 percent over a decade or more.

It is no small irony, though, that the sure winners from the continued spread of Internet commerce are old-economy companies -- whose operations are retooled. (Another big class of winners is consumers, who benefit from lower prices.) As with past innovations, from railways to cars, the companies that supply the technology itself can be risky investments indeed.

Back at Harvard, what did Sahlman say to the students who were considering start-ups but were scared by the stock market's loss of faith?
"I told them that if you have a good idea and a top team of people and can attract the backing of a blue-chip venture-capital firm, then there is no real personal risk," he said. "Even if the business fails, it can only be a great learning experience in a part of the economy that is sure to become more and more important.
"But then," Sahlman noted, "it is harder to take that advice than to give it. After all, I'm a tenured professor."
 

Source: Steve Lohr,  New York Times,  April 17, 2000