`Dot-com-itis' is the new gold fever

The Economy

June 25, 2000|By William Patalon III

As a medium that ties far-flung places together, the Internet has succeeded splendidly at making the world a smaller place. At the same time, however, this invention has indirectly transformed some of Canada's more remote mining communities into veritable ghost towns.

The actual cause of this irony of technological advancement is probably more dramatic than the effect. About two dozen Canadian mining companies, their profits down because of falling prices for raw materials, have reformulated themselves as Internet venture-capital funds during the past year - pulling the plug on their mining operations and consigning those distant mining towns to the tumbleweeds.

That this "dot-com-itis" can overcome gold-rush fever says a lot about the get-rich-quick mentality that seized the venture-capital arena late last year and early this one. Many upstarts - such as the miners-turned-venture capitalists - bulled their way to the financing table. But, with their lack of a track record and industry connections, the new entrants all too often were left with the less desirable deals, experts say. The likely upshot: As the financing frenzy reached fever pitch early this year, too much venture capital was chasing too few deals, and a lot of marginal start-ups found funding.

"There has been a proliferation of venture capital firms for the last two years," says Frank A. Adams, president and chief executive officer of Grotech Capital Group, a Timonium firm that's financed about 160 companies since its founding in 1983. "One thing that's axiomatic about our business: The best start-ups tend to seek out the best VC firms," meaning the newer firms are probably financing the poorest quality - and most risky - start-ups.

There will be economic fallout from this speculative mushroom cloud, insiders say. The start-up failure rate will climb, and the "investors" in the venture capital funds - including staid ones like pension funds chasing big returns - will get blistered.

As always, there will be an overreaction: Desperately needed venture financing will be tight - even for companies with sound prospects that normally would be deemed worthy. That could stymie growth of such key U.S. economic engines as the Internet-, information-technology and telecommunications hardware-and-service sectors.

"That's still probably the most fertile ground for start-ups," says Paul Engle, a manufacturing and technology consultant for the Baltimore office of Grant Thornton LLP.

In a technology-focused economy, venture capitalists are playing an increasingly important role.

When "three guys in a garage" come up with an idea for a new piece of software or equipment that will shoot your e-mail messages through fiber-optic pipes at the speed of light, these innovators go to venture capitalists (banks often see this as being too risky). These companies, in turn, are granted a partial ownership stake in the start-up in return for their money, management experience and a platinum Rolodex stuffed with executive talent and potential customers.

The usual goal is to take the company "public" - that is, to sell stock to mutual funds, institutions and even individual investors - which can land a venture firm a return of seven, 10, 15 or 20 times its original investment. That return sounds big, and remains so, even after absorbing the losses from the 30 percent of start-ups that blow away like tumbleweeds in a post-frenzy wind gust. But this frenzy will boost that failure rate significantly for venture companies new to the game, experts predict. According to PricewaterhouseCoopers, the accounting and consulting firm, money invested by U.S. venture firms in U.S. companies of all types rose from $4.31 billion in the first quarter of 1999 to $14.68 billion by the fourth quarter - which was a record, until eclipsed by the $17.22 billion stuffed into newbie firms in first-quarter 2000. Internet-related firms accounted for $10.8 billion.

The pace of deals has slowed markedly since then, since the sell-off in technology stocks doused the blazing initial public offering market for stocks - the venture capital payoff. Deals are still being done - but only the best ones.

Most venture capitalists, including the high-tech, miner 49ers - and not just the veteran players, as in the past - are now willing to wait to invest until they uncover that true piece of technological gold.

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