VENTURE CAPITAL FUNDING IN THE FACE OF WAR

VCs Discuss the Affects of War
on Investor Strategies and Behaviors

Press Release
March 19, 2003



PALO ALTO, March 19, 2003 - A panel of leading venture capitalists joined by a prominent Santa Clara University marketing professor took a candid look at how the impending war and the conflict between the U.S. and some of its most important trading partners might affect the strategy and behavior of investors.

David J. Blumberg, managing partner of Blumberg Capital, led the panel discussion organized by Silicon Valley's VC Task Force.

Blumberg quickly set the stage for this lively discussion citing that the impact of defense spending on the economy is declining. U.S. defense spending vs. the GDP has shrunk dramatically during wars and in peace time, from 130% during World War II, 15% during the Korean War, 12% during the Kennedy administration to just 4% currently. Even including the cost of the post-war rebuilding of Iraq, he said, "In a 10 trillion dollar economy, cost wise, this war is minor."

While opinions ran the gamut from little or no effect to a challenging economic environment for start-ups from 18 months to five years, the panel unanimously said that the pending war would not alter their own firm's actual investment strategy or decisions.

What was obvious in each panel member's opinion was the harmful effects of the underlying current of uncertainty. Those uncertainties - the length and the cost of the war, its degree of success, and the unknown backlashes such as retaliatory terrorist activities in the U.S. - elicited a variety of scenarios for the economy and start-ups specifically.

According to Tyzoon Tyebjee, professor of marketing at Santa Clara University, the first scenario is a short successful war that stimulates the dollar and consumer confidence, depresses oil prices and lets the good time roll again. The second post-war scenario is one that removes some uncertainty, but does not fundamentally help the economy, since the current economic situation is not related to the war. In this scenario, new financing is the least affected. The last scenario, a more precautionary perspective, looks at wars historically - they last longer and cost more than predicted - that plays out in rising interest rates, lower oil prices, lingering global trade effects, increased world diplomatic tensions and continuing terrorist activity.

Tyebjee, who has been working with a survey of the Silicon Valley business community on the war and its potential impact, says that preliminary results indicate that 40% of those surveyed believe the war will be bad for business, 30% are undecided, 20% predict a neutral impact, and 10% think the business impact will be positive.

Robert Winter, managing director, Rocket Ventures, observed that pre-war, we are heading into a recession with war talk picking up where the bubble left off, leaving businesses on hold with federal "levers" having minimal impact. "The fundamental challenge," said Winter, "is lack of liquidity." In this environment, funding has eroded. War environment observations include a high financial market risk due to terrorism, with the speed and success of the war being critical to an initial market recovery. On the post-war environment, Winter foresees a global impact for the next half-century with the balance of power and role of the UN changing global dynamics. This environment sees the start-up environment challenged for 18-24 months with an inflationary period and continued market challenges.

On a more optimistic note, Vish Mishra, venture partner, Clearstone Venture Partners, reminded the audience that Silicon Valley was built during the cold war. "Good ideas don't wait for good times," he said. Venture capitalists have a sense of risk. Today's technologies are employed in defense, communications and smart technologies. "People have to look for these opportunities," he said. "In the end, the global community will find China a safer investment environment, India a force of stability and Europe sulking, trying to truncate America's power or energy."

Uncertainty again came through from Andrew Kau, managing director, Walden International. Kau envisions a huge economic drain with the war exacerbating the United States' already strained relations with the rest of the world, creating a bad outlook for start-ups for 3-5 years. According to Kau, "the fabric of the international community is being ripped apart and will take a long time to repair."

"Because venture capital investment cycles stretch over many years, the impact of war won't have a significant impact on start-ups," said Alex Gove, vice president, WaldenVC. He said he was more concerned about budget deficits, corporate discipline, and investor confidence. Since the U.S. is an integral part of the world economy now more than ever before, Gove said he was also concerned that "The U.S. will win the war but lose its soul." Gove cited North Korea as potentially a bigger threat to the U.S. than Iraq and wondered whether a war on Iraq will have a significant impact on U.S. security. "What is the uncertainty of a nuclear bomb or a bio attack in the next ten years? That is the bigger question."

Eric Buatois, general partner, Sofinnova Ventures, noted that there will always be money coming into the venture capital community. In spite of the war, venture capitalists still invest in the market. "The key is diversification," according to Buatois. But he noted that if Europe is nervous about war, it is not about the war itself, rather the war's resultant terrorism. "Europeans have lived with terrorism for years," he said, "and they are very afraid of it."

While the range of scenarios was wide, the recurring concerns and observations were hard to miss: we are operating in a time of extreme uncertainty with the investment community suffering from a lack of liquidity. China was repeatedly mentioned as a high-growth environment for low-cost manufacturing with a growing domestic and huge overseas market, while the U.S. market was portrayed by some panelists as more risky. Although, as Blumberg pointed out, the financial market's judgment of risk has pegged U.S. interest rates at the lowest in 40 years with foreign direct investment into the U.S. much higher than into China. Moreover, the U.S. still attracts the overwhelming majority of global venture capital investment, with the largest share in California.

The consensus was that venture capitalists are not operating much differently now than before 9/11, and that they probably won't operate much differently after a war. There are strong entrepreneurs with good business ideas seeking capital. Companies will still be built and venture capitalists will continue to invest.

About the VC Task Force

The VC Task Force is hard at work building a suite of services for the venture capital community. Established in 2001, the VC Task Force provides a combination of business, legal and financial programs that provide real-time strategic and tactical information for venture capitalists and their portfolio companies. The Task Force also provides a forum for venture capital firms, institutional investors and portfolio company management through which they can share ideas, mutual concerns and information.

For More Information, Contact:

June Riley
VC Task Force
650-968-1304
rj@vctaskforce.com

Richard Wood
Sand Hill Partners (PR Agency)
650-631-0123
partners@sandhillroad.com

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