Capital Steps: Getting VC’s Attention
The venture capital community has virtually ignored the cable industry for the past several years. But that might have been less a problem with VC vision than a function of the industry’s own blurriness. What with consolidation, the emergence of wireless, and other issues, where cable intended to go has not been entirely clear. Recently, however, the industry’s direction has become better defined, and that seems to be gradually drawing VC attention.
A recent PricewaterhouseCoopers Money Tree Report, issued by PWC and the National Venture Capital Association, is clear evidence of the VC community’s vision of cable. Venture capitalists invested $25.5 billion in 3,416 deals in 2006, a 10 percent increase in deal volume and a 12 percent increase in dollar value over the previous year. And, it marked the highest level of investment since 2001.
Very little of that, however, was invested in the cable space. Few VCs directed money into the cable industry and to its cast of supporting manufacturers, hardware and technology companies. The trickle from the funding faucet for start-up companies and emerging technologies, along with the financing of the various stages in a company’s development process, was negligible.
Yet despite cable’s low position on the VC community’s radar screen, there are signs of a momentum shift toward the cable industry as a whole. Companies such as Vyyo, Vyatta, ExtendMedia, Ensequence and Ikano have recently secured funding.
“Up until a year ago, there were few new dollars. Now we’re beginning to see some IPOs, optical fiber investments and wireless companies, and the interest of the VC community is being rekindled,” says Tracy Lefteroff, global managing partner for PricewaterhouseCoopers. “There’s a more positive vision of cable by the VCs. There’s not much activity with the big companies, but there are some venture-backed deals. People are looking at major companies building out their infrastructures again.”
Investments by year (1995-2006)
VCs are also looking to share the risk, a strategy that blossomed after the dot-com debacle and “drive-by funding, irrational exuberance” of the late 1990s and briefly into the new millennium. Added Lefteroff: “I think we’ll see VCs making sure there are deep pockets before they [enter] into ventures. We won’t see pure ventures by themselves. They want to share the risk. And right now, wireless is where it’s headed for the VC community. That’s where the money will stay.”
And there’s no question wireless is where the VC money is. Nearly $1.3 billion was poured into the space in 2006, according to the MoneyTree report.
Nevertheless, interest in the funding of start-up companies, particularly those with compelling new technologies, is growing. “We like the cable industry because it’s embracing new technologies and it’s trying new things, like VOD, which was a calculated technology that’s paying off. Now, there’s HD, interactivity and addressable advertising, and new business models are being embraced. We’re seeing more interest from the VC community recently, and that’s a positive sign for the cable industry and investors,” says John Kim, managing director for H.I.G. Ventures, an early stage VC company.
Bridges will have to be built to attract more VC attention to the cable space, however. “Most VCs aren’t real cable friendly. But with the investments in Broadbus and with BigBand’s recent IPO, that might help VCs be more favorable toward cable,” says Andy Paff, president and CEO of CedarPoint Communications, a company that found some early investors and has moved through various rounds of financing.
Consolidation, Paff admits, has been the double-edged sword for the cable industry and its ability to attract VC dollars. “It hurts and helps. If you’re embedded in the top two, three MSOs, it helps. But it’s a tough sell unless you get validation from them. The small companies that have succeeded have been validated along the way,” he says.
And why the tough sell for start-ups to secure financing? “It’s never been easy, but scrutiny is much greater and technologies must be connected to ROI, business models and time to market,” Paff says, referring to return on investment. “Real world realities must be thought out and you must understand the economic model and the technology model before asking for funding. VC companies are very smart about both the business and technology sides, so you need more than acronyms. But there are lots of opportunities in this world of convergence and IP,” Paff maintains.
The near absence of VCs in the cable space recently has strengthened the position of homegrown investors, who have a slightly different take on venture capital than traditional VCs. The opportunity for investors such as Motorola Ventures and Comcast Interactive Capital (CIC), an investment fund managed for the MSO Comcast Corp., is from a strategic standpoint, says Sam Schwartz, managing partner for CIC. CIC has helped fund CedarPoint, Broadbus and others.
“We’ve really focused on companies that are developing technologies unique to cable. We sit on the boards of 25 companies and help guide them through the mine field. We’re now seeing more companies being embraced by larger companies and we’re very sympathetic to businesses whose only customers are U.S. cable operators. The VCs would shy away from those, since they’re betting the entire company on four to five major companies,” he says.
CIC, he adds, may be betting on new technologies in the next few years. “Advertising and commercial are the two new growth areas after VoIP and VOD have played out. Another is content delivery networks. There’s a lot happening in the video space online, along with peer-to-peer video. We’re looking at what role we can play to enhance that.”
Home networking technology and whole home network management, via CIC’s investments in Intellon and Tropic Networks, are two additional key categories for the fund.
Motorola Ventures has its eyes on the same home networking prize, and is focusing its funding attention on the emerging home networking space, says Reese Schroeder, managing director of Motorola Ventures.
“We are interested in the digital home and investing across that space in applications, hardware platforms and recently, HD compression video.
We’ve also just invested in Ruckus Wireless and the mobile TV company, GoTV. We’re being consistent in our investments in moving content around the home and helping to expand our set-top box business,” Schroeder says.
Motorola Ventures has an annual allocation for funding activities, and isn’t a traditional VC fund, Schroeder notes. “We operate closely with our businesses, meet regularly and are up-to-speed on our businesses and their needs. We’re looking for companies with a strategic fit for Motorola.”
And what does a VC-type fund like Motorola look for in a company with a compelling technology that fits into its strategy? “First, a company must think about its audience and how can it fit with Motorola and its value proposition. Second, it must have a strong management team, not just good technology; and third, it must have compelling, differentiated and protectable technology. The average size of an initial investment is $3 million to $5 million, with subsequent rounds of financing,” he adds.
Securing those subsequent rounds of financing can be tricky, even maddening, for many start-ups, however. Says Lefteroff: “VCs can’t afford to put so much money at risk. It’s about capital efficiency, and growth rates are slower, so VCs are monitoring their risks. They’re not afraid to pull the plug and shut down funding at any stage.”
Vyatta Inc., which brings commercial-quality, open-source networking products to market, recently received $11 million in Series B funding from CIC and knows all too well the funding gauntlet laid down by major cable players such as Motorola and Comcast, and the VCs.
“We must make sure our vision is aligned with theirs, and know what drives their business. If those are disingenuous, it won’t work,” says Kelly Herrell, CEO of Vyatta.
Vyatta has secured funding from mainstream VCs as well, including JP Morgan Partners, ComVentures and others, totaling $18.5 million. There were painful lessons to be learned in getting there, however.
“You must truly determine if you’ve built an Everest technology (built because it was there) or that it will address a market. I don’t advise creating a market. You must also understand the macro trends and if those trends are increasing or decreasing. You need discipline and a highly valuable product for the company,” Herrell says.
You also need patience, particularly with potentially meddlesome board members representing various investment companies. Adds Herrell: “One point-of-view is that they meddle. The other is they help. It’s usually the strategic investor that helps.”
For strategic investors such as CIC, Vyatta-type companies are high on their wish lists, and playing a more active role in their development is a priority. “Our role is active and hands on with business development and the strategic plans. We have strong industry relations, so we can open doors to other MSOs. Vyatta has a unique capability with their management team in the open source space and we feel open source will make its way into networking. There’s a number of technologies we like in the open source space, and we’ll be tracking those. But we always try to find companies with sound business models,” says Deepak Sindwani, principle at CIC.
Yet for the VC community, finding those companies, either directly or indirectly connected to the cable industry, with potential upsides and worthy of funding, remains a tedious process.
“Consolidation has made being a vendor a lot worse, more political and less predictable. So, it’s hard to anticipate how people will play the standards game, while MSOs are making their own standards. Nothing comes from consolidation in regards to investment opportunities. So, the criteria for what we invest in is tighter,” says Gary Lauder, managing partner for Lauder Partners LLC, a VC company specializing in Internet and cable TV-related technologies.
Vyatta, with its open source technology, is one of a number of emerging technology companies that has secured VC financing.
BRAVE NEW WORLD
There are signs of brightening skies for cable in the VC forecast, however. Adds Lauder: “Broadband has opened opportunities, and IPTV is a brave new world that’s growing rapidly and will give cable a run for its money. There’s good upside potential to interactive TV, and the combination of IPTV technology and cable will create all sorts of interesting possibilities for cable. It all depends on how the cable industry embraces it. Today, investors want to see a diversified customer base. Without it, there’s a risk of too much control by one customer.”
Investors also want to see some transparency in a company vying for funding.
John Burnham, vice president of marketing for Brix Networks, said, “For us, the pain relief for VCs and entrepreneurs was around IP, and a balance of innovation and execution. We knew how to do that. It’s never easy to raise money, but our message was clear: service assurance for IP and clearly identifying the pain and having a scalable architecture. Then execute on the business plan. That’s what we brought to the VCs.”
Brix Networks, a provider of converged service assurance solutions, has secured funding from VCs such as Charles River Ventures and others.
And funding from recognized VCs such as Charles River not only helps the bottom line, but with potential investors as well. Adds Burnham: “By getting Charles River funding, it really helps with our customers who see funding coming from a recognized and respected VC company. But we’ve had to earn everything, and show a clear balance of innovation and execution.”
For Ruckus Wireless, which received $5 million in first-round financing, then another $16 million in subsequent rounds, including a portion from Motorola Ventures, the funding was about proving its technology could actually deliver what it promised.
“Motorola was intrigued with what we did, but didn’t really believe we could do what we said we could do–extend IP service inside the home without wires. They were concerned about market potential, the business model, etc. and wanted to see sustained growth. We’ve delivered $7 million in revenue the second year after $1 million the first year, and we’re seeing sustainable growth margins. And, we have a multi-pronged strategy, including the small business market. I think that has impressed Motorola,” says David Callisch, marketing director for Ruckus Wireless.
Yet for many smaller start-ups such as Ruckus, the thought of a gaggle of board members representing several different investment companies controlling their futures is, well, not exactly their chosen course.
“VCs are great, but they typically take board seats and tell you how to run your company. Not to undermine what they do, but the key for us is to raise as little financing as possible and do the most with what we have. A milestone for us is to break even. But when you’re moving into new markets, it does take more money,” concludes Callisch.
And more of it is expected to come from the VC community, the private equity sector and strategic investors such as CIC and Motorola Ventures, experts maintain.
“It’s about customers getting people used to new technologies. VCs are looking for companies that incrementally make that happen. Cable will be a huge part of the communications sector, and I think we’ll see more smaller deals. Consolidation is a key as well. We’re down to a few big companies, but they’re looking at breakthrough technologies too and want to see new technologies develop, so they are ponying up,” says Lefteroff.
And those companies want to see a shortened time to market, Paff maintains. “If a technology helps do installs faster, for instance, then you have to ask how it gets deployed in the time frame that makes sense. Many vendors miss that window. And with consolidation, it shortens the targets. The investment community has been burned in that environment.”
Creating an environment for funding that’s appealing to the VCs takes a veritable tool kit of innovations and business savvy. “The three biggest areas are market timing, market size and business models. Those are the three biggest areas companies can break their picks on. A year delay could be caused by any number of factors, and it’s not uncommon. But if a company doesn’t have an accurate view of the market timing and a compatible business model, it could mean life or death,” cautions Louis Toth, managing director for CIC.
Nevertheless, there are signs of change. Concludes Paff: “The VC hot buttons are IPTV, iTV, IMS and next-generation architectures and what do WiMAX and 4G look like. There’s an opportunity for agile new technology companies in the world of convergence. The VCs are convinced there’s a pony out there and that companies are extending services, like wireless, so it’s making it easier for VCs to get around the traditional view of cable. It’s now considered a winner.”
Just who wins or loses out on VC funding is likely to be determined by the ability of an emerging technology, software, or hardware company to assemble all the pieces of a deployable business model, and its tolerance for pain as it moves through the funding process.