Sarbanes-Oxley Act impacting startups, too

New laws are like new drugs, it’s the unintended side effects that can hurt you.

In the wake of the dot-com bust and accounting scandals of 2000 and 2001, the federal government stepped in with a new law, the Sarbanes-Oxley Act of 2002, to protect investors.

But some entrepreneurs are saying the new laws are too broad and are affecting private companies, which they weren’t meant to regulate.

“Part of it’s tangential in a sense unrelated to the new laws’ purpose,” say Ken Fromm, a San Francisco-based entrepreneur.

Fromm now works as director of business services for enterprise software startup Modulant Inc. of Charleston, S.C.

He says an unintended side effect of Sarbanes-Oxley is hurting some startups.

“Any company that we’re looking at to get funding from, any companies that we want to get acquired by and any companies that we want to be in a partnership with have additional measures they have to go through in order to do business with us,” he says.

Fromm says this can be twice as hard for private startup companies dependent upon venture capital from larger public companies.

In the past, a public company that wanted to form a strategic partnership with a private startup to develop a new technology had an option to form a limited partnership called a “special purpose entity.”

That allowed a technology-sensitive company to invest money in possible breakthrough products without alerting its competition by disclosing the investment expenses in its quarterly or annual reports.

Making matters confusing, the U.S. Securities and Exchange Commission, the federal agency in charge of enforcing Sarbanes-Oxley, has no simple mathematic litmus test to determine when one of these “off-balance sheet” investments by a public company should be reported.

The SEC says off-balance sheet investments that “have or are reasonably likely to have” a current or future effect on the public company’s financial performance, should be claimed on earnings reports.

That can hurt a startup that may have trade secrets or emerging technologies that would be endangered by public disclosure.

“We’re looking at additional funding from a company and with this ‘special entities’ provision in the new laws Å  they may have to include us on their books — which is not something either of us wants,” Fromm says.

This is a direct result of the Sarbanes-Oxley Act as well as other federal accounting regulations of public companies.

Startups that already are facing a squeeze in VC funding are facing more red tape in corporate partner financing, Fromm says.

But, one prominent Cupertino software company, known for investing in startups, says so far it’s been unfazed by the new laws.

“I spoke with some of our finance team about this and I do know that we have not yet been impacted by Sarbanes-Oxley,” says Genevieve Haldeman, a spokeswoman for Symantec Corp. “But that doesn’t necessarily mean that we won’t be.”.

Market watchers have been warning of this danger for months.

Shortly after Sarbanes-Oxley became law eight months ago, Burlingame-based Forbes magazine publisher Rich Karlgaard wrote a column ruminating that well-meaning lawmakers may be killing viable companies before they leave the womb of their incubators.

“The dilemma for public policy makers is that most entrepreneurs do fail,” Karlgaard wrote, explaining that in these cases market conditions are more likely than misconduct to kill a startup.

Karlgaard also argued management at startups could be pressured by legal advisers to tone down the cocky entrepreneurial spirit out of fear of possible lawsuits if the company ever goes public or gets acquired by a public company.

“That would be a travesty,” he wrote. “Entrepreneurs are neither saints nor sober-minded.”

Fromm says the new regulations are expanding beyond their legislative boundaries.

“You’ve got these regulatory issues written for public companies spilling over into private startups,” he says.

Magazine icon predicts dot-com resurgence

Red Herring co-founder Tony Perkins still has the fever for the Internet and journalism

Tony Perkins has been at the forefront of Silicon Valley’s technology industry for the past 15 years. Through his work at Silicon Valley Bank and as a co-founder of the now-defunct Red Herring magazine, Perkins has consistently ridden the crest of each technology wave that washed across the valley.

His current project is a dot-com startup he funded with $50,000 of his own money. Called AlwaysOn LLC, it is a Web-based hybrid of business reporting and online journals popularly called “blogs” that he predicts will turn traditional media on its ear.

Biz Ink reporter David Speakman recently spoke with Perkins at Buck’s Restaurant in Woodside about AlwaysOn, which he eagerly showed off from his wirelessly Apple PowerBook. Perkins also talked about the health and entrepreneurial spirit of Silicon Valley.

You’ve said before that the success of eBay Inc. inspired you to attempt to apply its model to media on the Internet to create AlwaysOn.

It’s really built upon two trends. One is a Web media trend, the other is a business trend. A couple of observations in the reality of the market really inspired me to get this thing going. From a Web consumer standpoint, the clear winner in the first chapter of the Internet was eBay.

What eBay did was create an arena and invite its customers to come play in that arena. But if you think about it, all the things that go on in the arena that are of value to the customer are produced by the customers themselves.

But how can you apply that model to news media?

I think that is an incredible business strategy. I think that quality is the ultimate unique quality of the Internet. In the first generation of the Internet, all of the media companies really viewed the Web as an additional way to broadcast something. What AlwaysOn is about is creating a two-way relationship. An overwhelming amount of our content is generated by responses from our users. It can be described as the “ebay-ization” of media.

What does that mean?

eBay is the first example of the second-generation media company. Whether it was lucky or however you describe it, eBay created a business model where, again, most of the content they offer customers is customer-generated.

I think all the rules and the ideas concerning media and journalism are going to be incredibly challenged. I don’t even know what media is anymore. When you go to the AlwaysOn site, about 70 percent of our content is created by our members.

Would you call the invention of weblogs, or blogging, a disruptive technology in the media landscape?

Open-source media is probably the best way to describe it. Today most media companies control 100 percent of their content; even the letters to the editor that they edit before they publish. Traditional media is hesitant in participating in audience-generated concepts. They are worried about losing control of their content.

I think the Internet and blogging software is going to blow all the rules of journalism apart and we’ll have to put them all back together and see what happens.

Isn’t that already happening? Your traditional magazine, Red Herring, is out of business.

There is a cycle. Personally, I get great enjoyment out of doing things that are new and cool and this is the most fun I’ve had.

How will interactive journalism and blogging affect traditional media giants?

I think they are going to have to give up editorial control, as radical as it sounds, and allow their viewers and subscribers to participate in it. No offense to our profession as journalists, but I think the established media companies will have to decide whether they want to tap into the collective intelligence of their customer and subscriber bases to become a facilitator and aggregator for the rest of their subscribers’ ideas or whether they are going to continue to take a puritanical view and say “this material must pass through the editorial screen, and we completely edit and control it.”

Dot-com content companies have a bad reputation. How will AlwaysOn succeed?

AlwaysOn is already profitable. We already have many sponsors through advertising. A lot of our content is free to us and the cost of maintaining and operating the site has gone down dramatically. I spent $150 on software licenses and operate the site for $400 a month. And it’s scalable. The fact that I can run a virtual company and have a copy editor in the Netherlands and another copy editor out in Sacramento and we can all just operate wherever we are and can produce this Web site means that I’m not spending on office space or an information technology department.

You’re a native of Silicon Valley and have had a career that has taken you through some steep highs and deep lows. What’s your take on the current state of the region?

I expect this is going to be one of the most interesting times ever. I’m finding today more interesting things than I’ve ever found in my career. I’ve always been fascinated by the entrepreneurial process here. I take pride in exporting entrepreneurial capitalism around the world. I think that innovation means good margins and good margins raise the standard of living. I think that for an entrepreneurial capitalist one plus one can equal three; so everybody can win.

I’m very proud of the fact that people come from all over the world to start companies here. As you know, a third of the companies founded in Silicon Valley are founded by either Chinese or Indian immigrants. I think that’s cool. I think the global Silicon Valley is the American dream.

Cisco counts on new products to spur growth

Networking giant unveils line of Wi-Fi phones, plans to release other products in coming months

After weathering the brunt of the information technology (IT) spending downturn, the largest telecom networking hardware maker is lashing back with a slew of new products set to be unveiled over the next couple of months.

At the NetWorld/Interop tradeshow in Las Vegas April 28, San Jose-based Cisco Systems Inc. (Nasdaq: CSCO) unveiled a new line of wireless, voice over Internet protocol (VoIP) telephones using the 802.11b Wi-Fi wireless standard.

Cisco stock, which is trading at 26 times earnings, rallied slightly and closed April 29 up more than 1 percent at $15.14 a share.

Cisco predicts cost savings for companies, as its new Wi-Fi phones could replace pagers, cell phones and walkie-talkies currently used in health care, maintenance and warehousing industries, where workers are rarely at assigned desks.

Cisco thinks hands-on products are a key to its future growth.

“Investments that increase the productivity of end users have a more compelling return on investment than investments that only focus on IT support costs,” says Don Proctor, Cisco’s vice president and general manager of its voice technology group. “If an enterprise makes an investment that increases the productivity of 5,000 end users by only 2 percent, that is like adding 100 more people to your staff.”

But at least one analyst isn’t buying the hype.

“Despite the press releases and chest thumping Å  when all is said and done, we see this as more of a marketing event than a driver of sales in 2003,” says Raj Srikanth, a New York-based analyst with Deutsche Bank. “We do not think the
wave of new products that is just beginning to be unleashed in the space is likely to have any meaningful impact on market share and the financial performance of companies in the current IT spending environment.”

Cisco holds more than a 65 percent share of the data networking market, 76 percent of the Layer 2 Ethernet market (the most-common technology used for corporate local area networks) and 73 percent of its network switching cousin, Layer 3, which is used by internetwork packet exchange (IPX) and AppleTalk internetworking protocols, according to Redwood City-based Dell’Oro Group research.

Its competitors, such as 3Com Corp. of Santa Clara, Foundry Networks Inc. of San Jose, Extreme Networks Inc. of Santa Clara and Juniper Networks Inc. of Sunnyvale, carve up the rest of those markets.

“We believe Cisco’s dominance of the networking space will remain unchallenged in 2003 to 2004 and expect to see some minor shifts in market shares of other players,” say Deutsche Bank’s Srikanth, who predicts consolidation in the sector.

Deutsche Bank has a significant banking relationship with Cisco and many of its networking competitors.

Cisco, which closed its fiscal third quarter April 26, is in a U.S. Securities and Exchange Commission-mandated quiet period and is unable to comment on issues that may affect its stock price until after it releases quarterly earnings May 6.

“We look to the networking giant to post revenue of $4.555 billion, which represents a sequential decline of 3 percent,” Mark Sue, a New York-based analyst with C.E. Unterberg, Towbin wrote in a research report.

“In our opinion, overall networking equipment demand is likely to remain muted
during this constrained IT spending environment,” he says. “Cisco may be particularly impacted due to its large size.”

Some companies struggle with law

Under the Sarbanes-Oxley Act of 2002, the U.S. Securities and Exchange Commission enforces strict regulations on financial statement certification, reporting and disclosure controls, and procedures.

New certification rules require that CEOs and CFOs sign off on and take personal liability for their companies’ financial reporting. If any fraud is committed by the corporation, these officers take the fall.

New accelerated reporting rules take advantage of advances in computer technology and shorten the deadlines in which a company must report quarterly and annual reports, as well as certain stock trading activity.

In addition, new disclosure rules mandate that a company’s everyday consulting auditor cannot be the same firm that prepares public financial reports.

“Companies need to be more open and put more information on the table,” says Rick Barraza, senior vice president of investor relations at San Jose-based Calpine Corp. “I think that’s been well-received by Wall Street. É It gives more confidence and a comfort level for the investors.”

But unlike Calpine, some companies are struggling with compliance.

“You know who those companies are? It’s the $100 million companies with a small finance department,” says Bill Tulin, a partner at auditing and accounting firm Ernst & Young in San Francisco. “It’s the smaller companies that are public that don’t have the bench strength.”

That means they are going to have to spend money and time.

“At the end of the day, you’ve got to solve this problem in one of two ways,” Tulin says. “A company either hires the people itself or it hires consultants to help. There is no way around it.

“Basically, they are going to be held accountable,” he adds. “A lot of small companies have not had their feet held to the fire yet.”

Financial overhaul

Some accounting, auditing firms say last year’s Sarbanes-Oxley Act created welcome opportunities

Once considered boring or the harmless butts of bad business jokes, accountants shed that image after the record-breaking bankruptcies of Enron Corp. and WorldCom Inc. showed what can happen when bean-counters go bad.

In the aftermath of the Enron scandal and the implosion of “Big Five” accounting firm Arthur Anderson LLP, Congress passed the Sarbanes-Oxley Act of 2002, which overhauled the way public companies handle their internal accounting and public financial statements.

Enforced by the U.S. Securities and Exchange Commission, the law went into effect eight months ago and takes a multipronged approach to overhauling the corporate financial reporting process for public companies. It focuses on two areas: enforcing corporate accountability and eliminating the conflict of interest of accounting firms that provide financial audits as well as provide other services such as accounting and consulting.

Under new corporate accountability laws, if a company commits accounting fraud, the boss faces jail time.

“What people saw right away were the CEO and CFO certifications of the financial statements,” says Rick Barraza, senior vice president of investor relations at Calpine Corp., a San Jose-based power provider (see sidebar). “In our eyes this was nothing new. The accounting for this company has been certified for the last 17 years that I’ve been here. It’s just tighter control and more restrictions on directors and officers.”

Another part of Sarbanes-Oxley is the legal requirement that companies prohibit the accounting firm that does its internal audits to also handle its valuation for federal financial reporting.

“It’s really changed the go-to market strategy of the accounting firms,” says Bill Tulin, a Bay Area-based partner at Ernst & Young LLP. “Our future growth will really be driven in a large part because of Sarbanes-Oxley.”

Companies are much more likely to go out and hire somebody other than their financial reporting auditor to do internal audits, he says.

Citing new SEC regulations on how companies report financial numbers, Tulin says E&Y sees Sarbanes-Oxley as a way to develop a relationship with a company that previously turned to one of E&Y’s competitors.

In the past, some public companies have been criticized because they hired their auditor for other, strategic purposes such as tax planning or acquisition due diligence.

“Companies are embarrassed by the fact that they sometimes pay their auditors fees that are greater for the non-audit services than for the audit,” Tulin says, explaining why more companies are turning to other accounting firms for services traditionally handled by their financial disclosure auditor to avoid any appearance of conflict of interest — whether required by law or not.

He says the accounting industry woke up and smelled opportunity.

“Companies are forced to find a different auditor to provide certain services,” he explains. “In the case of valuation, they have to; in the case of due diligence, they don’t have to, but a lot of them prefer to do so.”

Sarbanes-Oxley also may be loosening the stranglehold the remaining “Big Four” accounting firms have on their market as more companies turn to a second accounting firm to handle strategic planning budgets and other internal auditing functions.

“We’re seeing an increased awareness of the need for strong internal audit programs,” says Bud Genovese, president & CEO of San Jose-based AuditOne LLC.

AuditOne focuses on the financial services market, including many of Silicon Valley’s independent banks. As a result of Sarbanes-Oxley, Genovese says his company has more opportunities.

“We see more attention to the adequacy of the coverage for internal audits. In the past, it may have been seen as an unnecessary expense or an expense companies could delay — and that’s not so now,” he says.

Genovese says a small and nimble company like his has advantages over its larger competitors.

“Some of the national firms may audit a semiconductor chip company one day and a potato chip company the next day,” he says. “We just focus on the financial institutions.”

E&Y’s Tulin agrees the opportunities are not limited to the “Big Four” accounting firms.

“What you’re seeing is this two-firm provider mentality that many companies have adopted,” Tulin says. “It’s created a different type of relationship among the accounting firms because now you may get referred into an opportunity by a competitor whereas in the past, you weren’t. That’s a really interesting dynamic shift in the accounting profession.”

Tulin says tax law attorneys also are benefiting.

“A lot of law firms have looked at Sarbanes-Oxley as a plus for [tax attorneys] because companies may not want to use their auditors to do certain tax planning work,” Tulin says

But is the new law working after its first eight months?

“There’s been a desire and need from investors for more information, more disclosure,” says Calpine’s Barraza. “The power sector has come under a lot of pressure going back to the PG&E and Enron bankruptcies in 2001.”

Calpine has been trying to distance itself from its more troubled competitors by presenting transparent financial disclosures.

“I think we’ve been doing a pretty good job of being more open with Wall Street to give them more insight into our business and a lot of that has come about from Sarbanes-Oxley,” Barraza says.

E&Y’s Tulin says it will take time to allow the public and Wall Street to once again trust accounting firms after the Enron/
Arthur Anderson meltdown.

“We’re going to have to wait a little bit for the situation to bake further in terms of companies implementing Sarbanes-Oxley,” Tulin says. “Once that starts to happen, people will have a sense that companies are doing a better job and gradually you’ll see a restored confidence in capital markets.”

Founder dead set on reviving Red Herring

Red Herring may be officially dead, but its founder has no intention of letting the defunct magazine rest in peace.

The last of the Bay Area-based national business technology magazines ceased publication after its parent company, Red Herring Communications Inc., filed for bankruptcy as its last issue hit newsstands in late February.

San Mateo-born Tony Perkins founded the San Fransico-based magazine with his brother Michael a decade ago.

Named after the red-lettered prospectus sheets for young companies planning an initial public offering, the magazine was profitable for its first seven years. Then it slowly withered as technology ad dollars dried up.

“Ultimately we’re going to revive it,” Perkins says.

He may have some hard bargaining ahead to regain control of the magazine, which is tied up in bankruptcy.

“He washed out his Red Herring venture investors,” says media consultant Mitch Ratcliffe, CEO of Tacoma, Wash.-based Internet/Media Strategies Inc. “Whatever decision is made about the purchase of the name ‘Red Herring’ and the archives of the old publication would probably have to go through the bankruptcy court.”

Ratcliffe speculates that since Perkins left investors sitting on the losses, the court would ask him to negotiate directly with the largest investors for the name.

In the 10 years Red Herring was published, it raised about $40 million in venture funding, with Foster City-based venture firm Broadview Capital Partners LLC emerging as the largest stockholder in the publication.

“Unless they did something really egregious, I can’t think of a reason not to sell a closed company’s assets back to its founders,” says Sharon Wienbar, a director at BA Venture Partners in Foster City.

BA Venture also has had companies in its portfolio fail and sell assets back to the founders at a loss.

“It’s good karma if nothing else,” she says, explaining that a VC has an added incentive to get a failed startup out of bankruptcy so it can write off the losses on its taxes.

Perkins didn’t explain how he plans to finance a Red Herring buy back or ressurection. Broadview would not comment.

“[Perkins] is going to pay pennies on the dollar in any case,” says Internet/Media’s Ratcliffe.

Still, in a year challenging all advertising-dependent media, 2003 may not be the best year to resurrect a dead magazine.

“The advertising market has been terrible for the last 28 to 32 months, depending on which publication you are at,” Ratcliffe says.

Acknowledging that, Perkins says he plans to wait until after the war in Iraq winds down and the tech economy show signs of life before relaunching Red Herring.

“When? I really can’t say at this point, but over the next couple of weeks, you may hear some announcements about the revival,” he says.

Ratcliffe says the dusted-off magazine better not look much like the old Red Herring.

“Upside, Red Herring, The Industry Standard and all the other business magazines that came out of the Bay Area were a product of not just the Internet bubble, but the tech explosion of the late 1980s,” Ratcliffe says. “It’s not surprising that we should hit a time when the advertising market is severely depressed.”

According to figures from New York-based Magazine Publishers of America, the economy already is perking up for most magazines. Total magazine advertising revenue for March 2003 was up 11.6 percent from last year to $1.6 billion, the MPA says.

But tech advertising was an exception. It fell 6.7 percent to $92.2 million in March, according to MPA figures. That fall hurt magazines like Red Herring, which saw year-on-year advertising billing fall 19.6 percent to slightly more than $1 million for its last issue.

But Ratcliffe says there is still a market for a national technology business magazine and that Red Herring should learn a lesson from the publications that have withstood the test of time.

“Forbes and Fortune are not in trouble,” he says. “The reason they survived is that they are about building and running a business over the long term. Red Herring and Upside, on the other hand, were about getting rich as fast as you possibly could.”

Regardless, Tony Perkins remains a cheerleader for Silicon Valley’s entrepreneurs.

“I think this is the Athens of the Information age,” he says. “I think it is a good process to take pride in exporting entrepreneurial capitalism around the world.”

Perkins says although he is committed to bringing Red Herring back, he doesn’t plan to be as hands-on as he was 10 years ago.

“Will I spend most of my time this year planning another magazine? Probably not,” he says. “I will be involved in the relaunch of Red Herring and will enjoy that, but I will spend most of my time further exploring the Internet and the Web because I think this is an incredibly exciting time to be focused on that.”

Merger leaves TiVo in limbo

A proposed mega merger flooding the pay-TV industry has some wondering if one high-profile Silicon Valley company will be swept up in the process or left as debris in the deal’s wake.

San Jose-based digital video recorder (DVR) maker TiVo Inc. (Nasdaq: TIVO) saw its share price fall by more than 15 percent to $4.49 a share April 11 after Australia’s News Corporation Ltd. said it would pay $6.6 billion to buy control of the parent company of El Segundo-based satellite television service DirecTV.

That’s because DirecTV may be TiVo’s most important business partner, accounting for a large share of TiVo’s customer base, and News Corp. already owns a competitive DVR technology that investors fear could replace TiVo.

“We estimate that approximately 220,000 of TiVo’s 625,000 subscribers are DirecTV customers,” says David Farina, a New York-based analyst with William Blair & Co.

“In the U.K. markets, News Corp. offers a similar TiVo-like DVR through its Sky-branded [satellite] service,” Farina says.

Some TiVo shareholders worry that News will dump TiVo for it’s own technology. But TiVo says that’s not the case.

“We don’t see anything changing,” says TiVo spokeswoman Rebecca Bear. “It’s business as usual.”

TiVo declined further comment on the DirecTV merger.

William Blair’s Farina says there are many reasons News is unlikely to ditch DirecTV’s partnership with TiVo if the deal to buy DirecTV succeeds.

“First, this deal will take at least a year to get through all the necessary regulatory operational hurdles,” Farina says. “At that point, we estimate there will be about 600,000 or so DirecTV customers who subscribe to the TiVo service.

News Corp. already has said it doesn’t plan any major changes at DirecTV, including its relationship with TiVo, for at least two years. It would not elaborate.

“At that point, we estimate there would be nearly 1 million DirecTV/TiVo customers, or about 10 percent of [DirecTV’s] customer base,” says Farina.

“Second, TiVo is the best brand name in the DVR market and is a value-added service that competes” with digital cable and satellite TV competitors, he says.

Currently TiVo’s market share is second only to DirecTV competitor EchoStar Communications Corp.’s Dish Network of Littleton, Colo., which has an estimated 720,000 DVR customers. Dish developed its own DVR technology.

But most Wall Street analysts point to forthcoming competition from digital cable TV companies rather than News Corporation’s European-based DVR technology as an emerging threat to TiVo.

The consensus is that News may not feel any pressure to drop TiVo or standardize its DVR and other interactive TV operations since both current platforms are in nonoverlapping markets and are money generators.

Farina says TiVo offers a more robust service that is a profitable business for DirecTV.

“We estimate DirecTV makes about $2.50 a month per TiVo subscriber, which is a very high-margin vertical service for the company,” he says. “All the heavy lifting in terms of contract negotiation has been completed, allowing DirecTV to continue collecting highly-profitable [TiVo-generated] revenue.”

Farina says instead of dropping its service, News Corp. may be interested in buying TiVo outright. Other analysts contacted by Biz Ink, acknowleged privately that a TiVo buyout has been dogging the company since it went public in 1999.

“Although a very speculative event, the opportunity does exist,” Farina says.

DirecTV owns about 9 percent of TiVo, of which News Corp. will gain control, making it the second-largest corporate TiVo shareholder next to AOL Time Warner Inc.

“Since TiVo has such tremendous brand recognition and loyalty within its customer base, perhaps [News Corp. CEO Rupert] Murdoch would consider rolling TiVo out to his other companies,” Farina says.

Startups play waiting game for next round

A new study by research firm VentureOne of San Francisco shows not only is venture capital funding at a seven-year low, the length of time a startup has to wait between funding rounds has more than doubled in the past three years.

The over-funding of bad business models during the dot-com boom combined with a deadly-quiet initial public offering market has venture capitalists scrambling to keep from losing their investments.

VentureOne says of the 6,093 private venture-backed companies it knows of, only 1,482 received follow-on funding in 2002.

“The fact that there is a very large pool of private companies, the great majority of which did not raise follow-on financing last year while the median time between financing stretched to 19.5 months, presents significant challenges to both investors and entrepreneurs,” says Gil Forer, global leader of Ernst & Young’s venture capital advisory group in New York.

He says that although some of those private companies, such as Mountain View-based Google Inc., are already profitable, it’s important for startups to turn a profit or find a buyer before their VC money runs out.

Allan Thygesen, managing director at venture investor company The Carlyle Group in San Francisco says this affects thousands of companies born in the dot-com boom.

“Companies that were funded during the bubble that are still around, haven’t had an exit and haven’t been shut down yet, are
living on various kinds of life support from their existing investors,” Thygesen says. “I think that trend is continuing into this year but it is on the decline and I think it will work itself out over the next 12 to 18 months.”

Thygesen says that means the valley should expect a new string of bankruptcies and liquidations as well as M&A’s where venture firms sell — possibly at a loss.

“It’s not so much the deal activity has subsided, it’s more that the average price of those deals has come down dramatically. There are a number of well-financed private companies and public companies that are actively looking for deals at bargain-basement prices,” he says, explaining VCs are sometimes forced to swallow the bitter pill of a buyer’s market.

“Some return on investment is better than none,” Thygesen says.

Wells Fargo growth challenged by stock prices

While it may make strategic sense for Wells Fargo & Co. to use a huge bond offering to go on a small-bank buying spree to protect its turf, industry insiders say stock prices, the currency of the buyout, are working against the San Francisco giant.

Wells Fargo says it recently sold $3 billion dollars in 30-year convertible debt securities and may sell an additional $450 million in debt to build a war chest.

The bank joins a growing trend among its peers, saying current interest rates proved too tempting to ignore.

“We were able to secure some very attractive funding due to timing in the market,” says Wells Fargo spokeswoman Janis Smith.

“This arrangement represents cheap, opportunistic financing for us,” she says.

But $3 billion is a lot of money and Wells Fargo is tight-lipped about what it will be used for.

“It’s for ‘general corporate purposes,’” Smith says, quoting her company’s press release. “That could include possibly buying back stock or we could refinance debt at a lower rate.”

With $370 billion in assets, Wells Fargo, is the fifth-largest U.S. bank. Many of the 23 Wall Street analysts who cover Wells Fargo (NYSE: WFC) speculate that the bank may be raising money to buy one of its competitors to get even bigger.

“That’s the first thing everybody asks” Smith says. When pressed, she does concede an acquisition would fall under the “general corporate purposes” definition.

As the banking industry continues to consolidate, Wells Fargo’s consumer banking competitors continue to move in on its Bay Area home turf. Recent examples include New York-based Citigroup Inc.’s purchase of Cal Fed Bank and Minneapolis-based U.S. Bancorp’s acquisition of Bay View Bank’s 57 branches.

But A.G. Edwards & Sons Inc. analyst David Stumpf says Wells Fargo is under no pressure to go on a buying spree.

“We are no longer concerned that Wells Fargo may be feeling some pressure to pursue larger acquisitions,” Stumpf says.

He says the bank continues to grow organically by cross selling products such as insurance, mortgage refinancing and brokerage services. Stumpf does not own shares of Wells Fargo and his company does not make a market in the stock.

He says investors anticipating consolidation have pushed up stock valuations of banks, effectively pricing would-be deals out of the market.

Wells Fargo could be looking at expanding its other services in the insurance or brokerage sectors, Stumpf says. Both of those have seen stock prices plummet after a one-two punch from the dot-com bust and the 2001 terrorist attacks.

RBC Capital Markets analyst Joe Morford agrees that Wells Fargo’s cross-selling strategy is working and says the bank’s deposit business is seeing a benefit from the slumping stock market. RBC holds a stock position in Wells Fargo and has had an investment banking relationship with the bank.

Noting that roughly one-third of Wells Fargo’s cash deposits growth is due to mortgage refinancing, Morford says, “Wells is also benefiting from withdrawals from the equity markets.” He says Wells is becoming the proverbial mattress where people are stuffing their cash.

But Wells Fargo’s growth plans are not limited to cross selling.

“The bank did indicate that they are interested in pursuing deals on small community banks to fill holes in their current markets,” A.G. Edwards’ Stumpf says.

Stumpf says Wells Fargo has been successful in buying small bank groups in the past by developing close relationships with them before he merger.

Organic growth may be a more viable option than an expensive M&A strategy.

“Bank stocks are in a fairly tight range as the market is not distinguishing much between the strong companies and the weaker players,” Stumpf says. “This makes it much more difficult for the buyers.”

Wells says there are other ways to grow.

“In the Bay Area, we’ve opened about eight new branches this year,” says Tim Silva, Wells Fargo’s Santa Clara County market president. He was responsible for opening new branches in San Jose, Santa Clara’s Rivermark development and in the Pruneyard in Campbell and has more local expansion planned.

“We are fortunate that we are a big bank,” says Silva. “But we run our branches as community banks.”

Wells Fargo’s community banking operations are making money.

In it’s quarterly report issued April 15, that division posted profits of $1.06 billion, a year-over-year growth of 11 percent.

Overall, Wells Fargo reported a net profit of $1.49 billion in the first quarter ending March 31, an increase of 8 percent over last year.

According to Wells Fargo CEO Dick Kovacevich, his company reported earnings per share of 88 cents, beating the Street consensus by a penny. EPS was up 10 percent from the 80 cents per share recorded in the first quarter last year. That marked Wells’ seventh-consecutive quarter of record earnings.

“Wells Fargo continues to be one of the handful of companies that is generating both strong revenue growth and earnings per share growth irrespective of the economic environment,” Kovacevich said in a statement.

Bear Stearns & Co. analyst David Hilder agrees. He says the bank is the best-performing and best-managed bank franchise he covers. Bear Stearns & Co. does not make a market in Wells Fargo stock.

But how the largest Bay Area-based bank parlays its current good fortune into future prosperity is yet to be seen.

Biotech startups starving from dearth of IPOs

Too many players chasing too little money are dashing the hopes of Bay Area biotechnology companies trying to raise money in public or private markets.

Since last June, no biotechnology or bioscience company has debuted on a U.S. public stock exchange, according to a new report by merchant bank Burrill & Co. of San Francisco. A handful of biotech startup companies planned to go public during the past three quarters but withdrew because of the weak stock market.

First quarter 2003 follow-on public and private offerings for biotech companies worldwide totaled $2.8 billion, down from $6.6 billion in the first quarter of 2002, the report states.

Locally, the last health-related initial public offering (IPO) was last May when medical device manufacturer Kyphon Inc. of Sunnyvale debuted on Nasdaq, raising $90 million. Kyphon’s stock (Nasdaq: KYPH) is trading in the low $8 range, off more than 40 percent from its $15 offering price.

One 20-year biotechnology market analyst says the cycle is familiar.

“The biotechnology sector has gone through these sorts of opening and closing of windows for as long as I’ve been familiar with the field,” says Jeff Bird, a partner with Sutter Hill Ventures of Palo Alto. “The opportunity to take [biotech] companies public presents itself every three to four years. And the last window, obviously, was sort of at the tail end of the technology bubble in the 1999-2000 time frame.”

Bird says biotechnology and bioscience venture-capital veterans are not concerned about the dearth of IPOs.

“I think many investors, who have been at this a while, work on an operating assumption based on history, which isn’t always a perfect predictor,” Bird says. “But based on history, they go about the work of financing and building [a biotech startup] without the benefit of a public market for a three- to four-year time period.”

Because the majority of biotechnology venture investment is on a seven- to 10-year time frame, Bird says an IPO window should open two or three times in a venture capital funding life cycle.

But, with the current war in Iraq and the prospects of a double-dip recession, all bets may be off, Bird says.

“To the extent that the economy is pretty much bleak — and the war contributed to that — one might question [historical precedent] and worry about longer periods during which the public markets may not be open,” he says. “It’s really hard to soothsay whether the opportunity is going to come. But in 2004 or 2005, the IPO market will most likely open up again.”

But some startup companies will need money before that time to survive. Without an IPO to raise capital, startups turn elsewhere for funds. Many turn to venture capitalists, says Rich Peers, an attorney specializing in early-stage companies at Heller Ehrman White & McAuliffe LLP in Menlo Park.

“I think biotechs, which naturally have a longer cycle, have fared a little bit better in this funding downturn than other technology companies,” he says.

Peers says the technology boom and bust didn’t bleed as deeply into the bioscience sector.

“Valuations just got out of whack for tech and now that it’s time to raise more money, you just can’t raise anywhere near those valuations today,” he says. “I don’t think biotech experienced such a dramatic increase in valuations that you saw from some non-life-sciences companies.”

Sutter Hill’s Bird says many venture capitalists are willing to pay up for bioscience companies with products they believe in.

“For most private equity investors in the biotech space, folks are sort of feeling that we’re in a time that we’re going to need to finance our companies using our own moneys and, hopefully, corporate deal making, which has always been a very important part of financing these companies,” Bird says.

Corporate deal making ranges from licensing a technology to a cash-rich big pharmaceuticals company to full-blown mergers and acquisitions (M&A) moves.

“Some types of M&A transactions in this category are financing vehicle rather than one company trying to acquire a product or technology,” says Bird.

He points to the February merger of Sunnyvale-based Hyseq Pharmaceuticals Inc. and Variagenics Inc. of Cambridge, Mass., to become Nuvelo Inc.

“Variagenics was a company doing interesting technological evaluations of clinical samples, but I really think it brought a bank of cash to Hyseq and therefore was used as a financing opportunity,” he says.

“In other cases, there are technology-rich, private companies that merge with public companies that are cash rich, but technology poor,” Bird says.

But a marriage of convenience does not always fulfill its promise.

“I haven’t seen a lot of successes,” says Heller Ehrman’s Peers. “You’d think it would be a perfect fit — you take money from a company with technology that doesn’t work and match it with a company with good technology but is unfunded,” he says. “But corporate egos sometimes get in the way.”

Sutter Hill’s Bird says the bioscience IPO and funding problem will work itself through.

“This is a temporary phenomenon. There are too many companies with not enough critical mass either in financing or intellectual property,” he says.