A pathway to profits? Or a road to regrets?
Glenn House had stood at this crossroads before, as vice president for strategy at an Oregon software company. There he sought out young companies with promising technology that suited his employer's needs, invested in them -- and when all went well, tried to engineer an acquisition.
Last spring he was on the other side of the intersection, as chief executive of a 2-year-old Cambridge company, Atreve Software Inc., since renamed WebSpective Inc., now headquartered in Needham. The company produces load-balancing applications that smooth out delivery of Internet Web pages, and it needed investment cash.
Up stepped Cisco Systems Inc., the $8.5-billion California maker of computer servers used to direct Internet traffic, wanting to join in the financing alongside three venture funds.
House, who says WebSpective ultimately wants to go public and not be taken over, cheerfully said yes -- joining the increasing ranks of technology-based start-ups forging cash-rich alliances with big firms, each side hoping to gain benefits that outweigh the potential pitfalls.
Once viewed as a sure avenue to a takeover and resisted by many small companies, strategic relationships, partnerships, and alliances between giant technology firms and entrepreneurial start-ups are growing in number and frequency, reflecting the complexity of the Internet, telecommunications, and technology in general. And rich with the profits of their own successes -- Microsoft Corp. alone has $17 billion in spare cash -- companies such as Microsoft, Cisco, Intel Corp., and Novell Inc.
are welcomed as allies in promoting the development of software or other products. Along with the cachet that comes from associating with a big gun, small companies say they gain broader understanding of their industry and leads on new customers.
Also, House added, teaming up with a giant familiar with the Internet world is a form of insurance. "You want to work with a big partner who, when things get tough, understands the dynamics of the marketplace."
For their part, the big companies say while they hope to make money on these investments, their purpose is to support development of any product that will lead to greater use of their own technologies. "This is a limited way of outsourcing our research and development," said Chris Stone, Novell's investment overseer. Microsoft's senior director of business development, Greg Stanger, said: "We want to make sure that everyone who is going to develop something based on Windows, regardless of
what they might say in the press, is going to do as good a job as possible."
At the same time, big companies like being able to buy access to fresh perspectives. Ammar Hanafi of Cisco says his company's $2 million investment in Atreve and companies like it provide insight "on some of the issues of electronic commerce and that Web-based companies face. We get to work with entrepreneurial people."
The money these big fish have available to pass down the food chain is overwhelming. Microsoft says it now has 45 such investments, ranging from $1 million in several small start-ups to the multimillion-dollar stake it has in Andover-based CMG Information Services Inc. and a $1 billion investment made in Comcast Corp. last year. The company also plans to put up to $100 million more into technology-focused venture funds.
Cisco Systems since 1995 has made about 40 investments, between $1 million and $5 million each. Hanafi won't disclose the total but says about three quarters of these investments are aimed at "technologies that are emerging, where it is important for us to know what is going on." Like most of his peers, he hopes to make money on these -- but that's not paramount.
Novell, which set aside $100 million earlier this year for partnership investments, so far has put $20 million into nine companies, mostly in California. His prime objective is to help entrepreneurs who are developing software to support Novell's Network Service Directory initiative -- a program that aims to link every computer system in the world, in the same way corporate computer networks now can perform on a limited scale.
Statistics about corporate investments are elusive. "It is very difficult to get the entire picture about what corporations are doing. A lot of it is strategic and they are not likely to talk," said Jean Yaremchuk, research director at VentureOne, a California company that tracks venture capital investments.
VentureOne's limited count for 1997 found 46 investments in start-ups by corporations or corporate investment arms, for a total of $482 million. Through the first nine months of this year, VentureOne identified 27 such investments totaling $460 million -- a 61 percent jump per round.
Josh Lerner, a Harvard Business School professor, thinks as much as 30 percent of all investment in start-up companies may come from corporations. This estimate includes participation in privately managed venture fund rounds, where individual dollar contributions by funds and corporate players aren't broken out. That was the case in Cisco's investment in Atreve.
And then there is corporate investment in venture funds, also seldom disclosed. Lerner and Paul Gompers at the National Bureau of Economic Research in Cambridge found through VentureOne data that 30 percent of all venture fund investment in 1997 was from corporations -- triple the average for the preceding 10 years.
The last such wave of corporate involvement in start-ups was around 1980, when windfall oil profits and gains from defense buildups created mountains of cash for investment -- and led to such flops as Raytheon Co.'s ill-fated entry into commercial data processing and Exxon Corp.'s failed attempt to build office computers and fax machines. The current burst, says Lerner, is "on a lot better footing, far better thought out."
This time around the buyers are zeroing in on technology. And, although there are significant exceptions -- Microsoft's $425 million acquisition of WebTV last year is one -- they usually don't want full control -- just insights. "We target companies that meet our own strategy," says Stone of Novell.
Dorothy Langer, a Boston business consultant who specializes in partnerships, says the model for this activity was set in the pharmaceutical industry, which "couldn't develop drugs fast enough" to keep up with gains in entrepreneurial biotechnology. Microsoft was among the first high-tech firms to take the cue, she said.
Although alluring, partnerships are also risky. James Dolce, chief executive at Redstone Communications Inc. in Westford, warns that taking money from one company can lock a small firm out of deals with others. "The small company can't afford to put all its eggs in one basket," he said. Avid Technologies Inc.'s William Warner also warns against giving a single investor so much control that "they start to push the company toward ends that meet only that one corporation's needs."
Intel Corp.'s desire to invest $2 million in ServiceSoft Corp. of Needham last winter raised another concern for ServiceSoft chief executive David Tarrent. Intel was a customer for his diagnostic software, and "bringing a customer into the inner sanctum" made him nervous. "But once we did the deal they were so supportive. . . . Suddenly they became our buddies." One otherwise unattainable reward: Contacts with important computer industry standards-setting committees, who write agendas for future product development.
Not all stories have such a happy ending, to be sure.
America Online Inc. and Banyan Systems Inc. of Westborough became best of friends in 1995 when Banyan, a money-losing local area network supplier, decided to shift into Internet products. The first was Switchboard.com, a telephone listing site, which AOL agreed to feature on its computer network that now has 14 million members. Along with a deal to share advertising sales revenues, AOL invested $3 million in Banyan's Switchboard subsidiary.
Then AOL began pulling the plug. First it announced a rival to Switchboard, InfoSpace Inc., will get the "white pages" individual listings when the Banyan contract expires Jan. 1. Last week came the second blow: The "yellow pages" commercial listings will go to a Bell Atlantic Corp.-GTE Corp. partnership.
AOL said along with $31 million in upfront payments, the Bell Atlantic-GTE combo offered an experienced Yellow Pages sales force to sell local advertising -- an enormous, untapped market for Internet revenues.
Banyan's chief financial officer, Richard Spaulding, says AOL isn't pulling its investment. And AOL's imprint attracted other Internet partners, including the top-rated AltaVista "portal page," and corporate subscribers who pay for add-on services.
Outcomes such as these, says Lerner, the Harvard professor, are perhaps the greatest value of such partnerships. "We're talking here about visibility and credibility," he said, "that would be difficult to get in any other way.
© Copyright 2001 Globe Newspaper Company