November 8, 2001

By Bob Brown

BOSTON - The start-up CEOs and investors speaking on a panel here this week swear they've learned lessons from the ongoing IT market downturn that will help them make smarter business and funding decisions down the road.

The CEOs said they are much more focused now on getting tangible products to market than in trying to live off unproven technology. The investors said they are looking to put more experienced managers at the top of new companies and are looking beyond just selling or bringing public the new companies they fund.

Doron Kempel, CEO of storage network company SANgate, said one change in his company's approach can be seen in its acquisition strategy. Kempel, previously a vice president at EMC, said his company focuses "less on the promise of technology and more on demonstrable value of products" when considering acquisitions. Despite the fact that SANgate doesn't plan to roll out its products until the second quarter of next year, the company has $18 million in funding and bought two companies last year. But SANgate has scrapped plans to buy any of the four companies it was contemplating this year because none of them had progressed passed the technology concept stage, he said.

Kempel said the popular notion that the storage market would be immune to the problems that were battering other network market segments has been squelched by free-falling prices caused by fiercer competition than anyone anticipated. He described the outlook for the storage market as gloomy over the next two years, though he said there is opportunity for companies with innovative products.

Erel Margalit of Jerusalem Venture Partners , which sponsored the panel, said he continues to be optimistic that SANgate and other investments can be market leaders. "But what that leadership means is something different than it was a year-and-a-half ago," he said.

Margalit said his company had to reevaluate its expectations for CyOptics, an optical components maker pushing 40G bit/sec technology, as spending by carriers started to dry up and the demand for very high speed technology slowed. CyOptics brought John Pilitsis, an 18-year Lucent/Bell Labs veteran, on board in May because it was clear the company needed someone who could put in place the processes to sustain the company during tight times, yet prepare it to respond if and when demand booms.

Margalit says new companies and their investors need to be more innovative than ever these days, and can't just desperately look around to get acquired. He described a "reverse merger" in which privately-held Ethernet services company Cogent Communications - a Jerusalem Venture Partners investment - recently gobbled up the assets of publicly held Allied Riser, a struggling building local exchange carrier.

New companies also need to consider marketing their products first overseas if the U.S. proves too tough to crack during the tough economic times, Margalit said. He said this might be a good strategy for wireless equipment companies that don't want to get caught up in the current messy wireless environment in the U.S.

The panel, moderated by Harvard Business School Professor Paul Gompers, was dubbed "Financing Innovation In Uncertain Times: Where Do We Go From Here?" Gompers, an authority on venture capital, set the tone for the panel by sharing this sentiment that he's been hearing from entrepreneurs: "Trying to get money from a venture group is probably harder than it is for the Boston Celtics to get back to the NBA finals."

Gompers said reality is setting in for many investors and entrepreneurs after "lots of frothiness" in the venture market in recent years, a period during which "deals were being made that shouldn't have been done." But he noted that lots of interesting companies are being created today and that when the industry looks back several years from now, it will see that such companies did get financing. The same was true for companies financed in the late 1980s, the last tough period for venture financing, he said.

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