SOMETHING VENTURED: Scouting Out The Hidden Jewels


CHICAGO -- When venture capital investors learn the trade, they're taught several guiding principles.

Find the right company with the right product and the right management team - and get the right deal.

"That's high-level apple pie and American flag," said Marty Mannion, managing director of Summit Partners, a venture capital company that manages over $5 billion and invests in a variety of industries.

But there's more to it than that, Mannion and others in the industry say. Sometimes finding the right company means digging a little deeper and isolating characteristics that make one firm stand out from a crowd of competitors.

For Mannion, the make-or-break factor can be a company's balance sheet.

"A company that has a good balance sheet typically is better than you think, and one without a good balance sheet is usually worse," Mannion said.

In the go-go 1990s, investors were less likely to closely examine the nitty-gritty financial details. But in today's more conservative environment, such focus can pay off.

When surveying a possible investment, Mannion said, he looks at the company's days-receivable record. If a company can't get the money it's owed within 45 days, that raises a red flag. Maybe it's offering its product on some sort of trial basis and customers don't feel the need to pay back right away, or ever. Or perhaps the company just isn't paying enough attention to detail.

When Summit invested in Lincare Holdings (LNCR), a health-care company, one asset that attracted the firm was Lincare's ability to collect from customers.

"Lincare had an incredible system allowing it to collect in just 45 days," Mannion said. "Everyone else (in the industry) was at 80. It was an incredibly well-run business by every metric. They turned over their inventory 14 times a year and everyone else was six. They had a high cash flow. It allowed them to buy competitors that were less well-run."

A few years ago, venture firms looked first at a company's product, hoping it could make a big splash in an existing market. But now, with the economy weaker and customers less willing to shift vendors on a dime, a good product or a good market isn't necessarily enough. Sometimes investors have to find something unique.

"There's so much investor money out there going after the 'hot spaces' that it's easy to fall into a herd mentality," said Eric Gonzales, partner with DCM-Doll Capital Management, an early-stage firm in California focusing on communication, networking, software and Internet service companies that manages more than $1 billion. "Every four or five investments, we try to look for something that's out of the box. That's the expression we constantly use."

DCM isn't the only firm taking the "out of the box" approach.

When Focus Ventures, a Palo Alto, Calif., firm that manages just under $600 million, was looking for a new software and services company to invest in, it eventually put money into Wily Technology, a company that makes Java application management software.

"It's a new playing field without a lot of close competitors," said Steve Bird, a general partner at Focus.

George Bischof, another general partner at Focus, noted that Wily has demonstrated the ability to sell to over 100 different customers, which speaks to its ability to successfully execute on sales. "Some of Wily's products have helped save companies $1 million," Bischof said.

At Itochu Technology Corp., the business development and venture arm of Japanese conglomerate ITOCHU Corp., venture capitalists seek U.S. companies with the ability to make technology products that fit into the Japanese market.

Itochu is eyeing a small northern California company that makes wireless technology for cell phones. In the U.S., cell phones are common, but not cell phones with advanced functions. Those are more popular in Japan, and Itochu thinks this company has a product that, if properly molded, could be a hit with distributors across the Pacific.

"The product isn't quite right, but they're very in tune with adjusting for the Japanese market," said Frank Thibodeau, director of venture investment at Itochu. In this case, the company's willingness to change its product for a different market makes it attractive.

When Thibodeau learned the venture business, a mentor told him a company's management and its market were the top two priorities, he said. That hasn't changed.

"You have to have someone to sell to and have an advantage over competitors," Thibodeau said. "Product is probably less important than before, because the belief is that a great team with a great market will eventually find the right product."

Almost everyone these days talks about capital efficiency. If a company doesn't have a realistic plan to get to a break-even cash flow within two financing rounds, Gonzales of DCM usually isn't interested.

"You don't want to have to raise large amounts of money down the road in this environment," Gonzales said.

Successful venture firms also scout a market carefully before choosing a company.

Mannion, of Summit Partners, says his firm spends a lot of time "cold calling" companies to ask about their history, current market environment and competitors.

"You'd be surprised," he said. "Most will tell you a lot on the phone. When you talk to each company, they'll name three or four competitors, and dominating players get mentioned often. You can say, 'Ahh, that's the top player.' You want to invest in the top company."

(Daniel Rosenberg, one of several writers of the Something Ventured columns, covers the medical products and devices industry for Dow Jones Newswires.)

-By Daniel Rosenberg, Dow Jones Newswires; 312-750-4118; daniel.rosenberg@dowjones.com

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Updated June 4, 2003 11:00 a.m.

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