Jerusalem Venture Partners (JVP) has just closed a USD 400 million fund to invest in early-stage communications start-ups. Lisa van Beurden asked Adam Fisher, a principal at JVP, about the state of the market and the firm's investment plans.

LvB: How long has JVP been investing in the optical comms space?
AF: It all started in late 1997 with a company called Chromatis. That was our first foray into the optical market and was a systems company. Since then we have branched off into subsystems and components.

In this current economic climate, is it difficult to attract new investment partners and retain existing ones?
I guess what makes a VC [venture-capital firm] successful from a fundraising standpoint is being able to bring back your existing financial and strategic investors, and that is what we've done. Obviously there are those that have dropped out for their own reasons, but a lot have come back for this fourth and largest fund.

How is the current telecoms downturn affecting your plans?
It's a very difficult time. It's difficult not only because we are looking at lots of new companies, but also because we have an existing portfolio of optical companies to grow and take care of. On the upside, that gives us a lot of insight into what is happening in the market with customers, competition and fundraising. We're now setting a much higher bar when looking at optical start-ups. The other thing is that the pace of investment has slowed in the optical sector. There's a consensus among VCs that most sectors of the optical market are crowded and there's very little visibility over the next 12-18 months in terms of revenues and which technologies are going to make it.

What type of companies are you looking to invest in?
I think we are more inclined to invest in components and subsystems companies, but will not rule out systems companies. We can see a clear path to a return on our investment in the components sector, which is also the sector that we have more experience in.

What's so attractive about the optical components sector?
A lot of the slowdown in the market has occurred because component prices have not fallen much and there is a lack of availability for certain types. As a result, systems are still very expensive and that really hurts the market, especially when you've got carriers who are suffering their own problems, such as reduced profitability, slowing growth in traffic and bad public markets. Therefore, the optical communications market is feeling pressure from the top and bottom parts of the chain. However, we still feel that the components sector is the place where technology revolutions occur, where you get performance improvements, and where you are able to reduce the price of systems. That's why companies in the components and subsystems sectors are considered to be the most attractive investment at this point.

Which hot technologies do you plan to invest in?
We don't like to take too many bets on technology - we prefer something reliable rather than a science project. We're getting interested in all types of tunable technologies, such as tunable lasers, tunable filters and tunable optical add-drop multiplexers. We think that there are lots of opportunities there because with tunability you get extra functionality as well as price advantages by reducing inventory costs. Down the road we also see opportunities for companies that are using either materials or manufacturing expertise to create sophisticated platforms. This is clearly what we are looking for rather than a one-product company.

Do you intend to focus the fund on a particular geographic region?
No. In general, we focus on North America and Israel, but we are now also looking quite extensively at the European market.

How much of the USD 400 million fund has been invested?
We've made seven investments so far but it's still early on. A first-phase investment typically ranges from USD 5 to 8 million.

What do you look for when investing?
Firstly, it's a very strong and multidisciplinary technology team. It's also important for us that the people who found the company have a good understanding of the product they are developing and for which market and which customers. Too often we see companies that are too technology-oriented and that fall in love with their technology or their patents. You need to have a serious business plan for a serious company, not just a patent. That's the reality of the market.

How has the VC market changed during the past 18 months?
It has changed from optical companies being the hottest thing on the market. In the past, every VC had to have an optical components and an optical systems company in their portfolio. These days, most VC portfolios are overexposed in the optical sector and are not even looking at making any new optical investments. This is problematic because there are new and promising companies that probably should be funded, but may not be.

I think another thing that has changed is that instead of investing in technologies that create a disruptive performance, we prefer to invest in those that will bring a disruption in price. Reducing the overall cost of components and systems, whether it's through a new technology or integration, is more attractive to us than an increase in performance. Often an increase in performance comes with a certain cost and at the moment the market's not ready to absorb that.

Do you think that the market will return to its previous high?
I don't think that we'll see it returning to the way it was. I don't think that there will be room for so many companies to be funded. The optical components market has very few leaders. Even today, except for two or three companies, it's very hard to point to a leader in multiple categories. I still think that there's a chance to build a market leader in the optical components space, but very soon it will be more difficult to do so, and that will affect the amount of money being poured into the optical components sector.

What will happen to VC firms in these tough conditions?
You're seeing similar dynamics to what is happening in the high-tech market. Poor performance has an impact on the ability to raise funds, and if VCs are unable to show return on their investments, and cannot exit from their existing portfolio, then they will have difficulty raising funds for new investments. In the same way that consolidation is happening in the tech market, it probably ought to be happening on the financial side as well.

When do you think that market conditions will improve?
It's very hard to anticipate. Many people assume that 12-18 months is enough time for things to get better, but I think that the only reason they say that is because the next 12-18 months don't look good. The assumption is that if you can't see what's beyond, then it could be good. I wouldn't expect a recovery in the next 18 months.

This article originally appeared in FibreSystems Europe January 2002 p25