Where the Smart Money's Going in '07
Local Software, Telecom, Biotech Firms Figure to Get the Most Venture Funding

By Kim Hart
Washington Post Staff Writer
Monday, January 1, 2007

Six years ago, John Backus was sure he'd found a winner in Mobile 365, a Chantilly start-up that routes text messages between wireless companies. Backus, a partner in Reston-based Draper Atlantic Ventures, invested $7 million in it over the next few years. His confidence was rewarded in September when a California software company purchased it for $425 million, sending $50 million back to his fund.

That's the kind of deal Backus -- and just about anyone else -- would like to repeat in the new year. So where will he and other local venture capitalists look to put their money in 2007?

Companies that add features to cellphones are expected to be among the hottest venture targets, industry veterans say. Internet-based start-ups, software companies and biotechnology firms are likely to continue to dominate the Washington area's private equity landscape in 2007. And a few relative newcomers to the local scene -- energy and health-care companies -- may also win lucrative deals.

Nationally, venture capitalists plan to invest $29 billion this year, which is slightly more than in each of the past three years, according to the Arlington-based National Venture Capital Association. During the first nine months of 2006, investors in the mid-Atlantic region pumped $972 million into 153 deals, and they expect to be on track to invest a similar amount in 2007, according to a survey conducted by the Mid-Atlantic Venture Association.

As the economy has strengthened, the number of proposals landing on investors' desks has reached a two-year high, and even those who plan to increase their investments this year say they are being picky about the entrepreneurs they choose to back. Inflated prices and sluggish returns still pose risks.

"There's a lot more money in this region than there was just a few years ago," Backus said. "But there's a danger in trying to put too much money to work too quickly. . . . If you don't pay attention to the business model, there will be some high-profile duds."

Like their West Coast counterparts, local venture capitalists are looking for companies that sell customized software programs and consumer-oriented Internet applications. The so-called Web 2.0 movement, which has created a slew of interactive sites that cobble together user-generated content with personalized features, is still evolving, said Roger Novak, general partner of NovakBiddle Venture Partners in Bethesda.

But Internet start-ups that get a lot of hype could easily flop, he said, and memories of the dot-com boom and bust are still fresh.

"It's eerily like the 1999-to-2000 time frame, when we couldn't get enough of the new Internet. There's a big gap between what goes in and what comes out of Internet companies, and that makes me uneasy," Novak said as he took a break from writing his annual report -- titled "Who's Drinking the Eggnog This Time?"

Other sectors are generally expected to have a solid 2007. Software and telecommunications -- which received $147 million in venture capital in 2006 -- will probably attract similar attention this year. Investors agree that alternative-energy companies, which have been turning heads in Silicon Valley for the past two years, will gain more traction.

For example, GridPoint, a District maker of electricity management and backup appliances, got an infusion of $18 million from Goldman Sachs in October, in addition to $3 million from venture capital firms.

"I think we'll see a lot more of Congress's agenda focus on the environment," said S. Tien Wong of Opus8, a private investment firm in Chevy Chase. "D.C. is where the action is, not just in places with an energy crisis, like California."

An increase in biotechnology deals will reflect the continued development of the industry in Maryland and the addition of Janelia Farm Research Campus in Ashburn, part of the Howard Hughes Medical Institute. During the third quarter, $42 million went into six biotechnology deals in Washington.

Because of the lengthy clinical trials required to get a drug approved by the FDA, investors are less likely to bet on pharmaceuticals than on medical devices, which tend to produce smaller but more reliable returns.

While some deals are large, the number of local firms making investments in the area is relatively low. Bruce Robertson, a locally based managing partner with H.I.G. Ventures of Atlanta, which does almost half its deals in the life sciences industry, said he does not have any Washington area companies in his portfolio, despite receiving more than 1,000 proposals last year.

"We're looking cautiously, not because the markets aren't big, but because it's more expensive and risky," he said.

As the technology sector continues to recover and other industries enter the local market, the Washington area is emerging as an active and sought-after investment target. Several local firms have been aggressively raising more capital. In 2006, 200 firms in the region raised nearly $1.3 billion in new funds.

"That means our limited partners -- pension funds, universities and corporations -- have a lot of trust in our investors here," said Julia Spicer, executive director of the Mid-Atlantic Venture Association. "They're making good investments, getting good returns, and people are reinvesting in the region."

But the figures also reflect the larger sums investors are putting into individual businesses. Many local funds are now attracted to companies that need larger infusions of cash -- $3 million to $5 million -- rather than start-ups that need less than $1 million.

Unlike the late 1990s, when venture capitalists seemed eager to throw money at any two-man shop with a decent idea, they're now searching for seasoned entrepreneurs who have already acquired customers and steady revenue.

"Firms aren't doing as much early-stage investment anymore," Backus said. "Entrepreneurs looking for $2 million are having trouble finding it."

Jonathan Aberman, who started McLean-based Amplifier Venture Partners in 2005, has tried to fill that gap by investing more modest sums in promising companies. The firm recently contributed to a $1.75 million investment in FlatBurger, a New York start-up that distributes and tracks software components.

"We're getting a lot of concentration of capital in fewer hands," he said. "Investment's going to be more selective."