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4/29/2005
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Born Again

Silicon Valley, the site of busted dot-com dreams, is bustling once more as entrepreneurs focus on business' I.T. infrastructures

Businesses that expect to use technology as a differentiating factor had better keep an eye on where the innovation is coming from. "IT managers who forget about the Silicon Valley do so at their own peril," says Paul Holland, a partner at venture-capital firm Foundation Capital in Menlo Park. "Every year, something new comes out of it."

One of the key trends coming out of the area's tech industry is the software-as-a-service model, where vendors sell online access to applications through subscriptions. Indeed, some of Silicon Valley's most successful companies, such as eBay, Google, Salesforce.com, and Yahoo, aren't traditional hardware or software providers but have built technology platforms to launch services over the network.

Voltage Security co-founder Kacker "did the march" along Sand Hill Road in search of funding.

Voltage Security co-founder Kacker "did the march" along Sand Hill Road in search of funding.

Photo by Jeffery Newbury
Salesforce's $110 million initial public offering and steady growth in revenue show how quickly the age of software- as-a-service is dawning. Salesforce was built without venture funding, but Emergence Capital Partners, a Burlingame VC, secured a 1% stake in Salesforce from an internal owner before the company, which now has a market capitalization of $1.5 billion, went public. Emergence now has a $125 million fund to start software-as-a-service companies. Since beginning in 2003, Emergence has invested in Bay Area firms such as SuccessFactors Inc., a supplier of online employee performance-management services, and MegaPath Networks Inc., a supplier of broadband access and management services. SuccessFactors had 150 customers in 2004, its third consecutive year of 100% revenue growth. MegaPath was profitable in 2004, with revenue of $87 million, up 28% from the year before.

Gordon Ritter, a partner with Emergence, is eager for his company to get four to five software-as-a-service startups under way this year, and don't be surprised if a number of them hail from Silicon Valley. "We're getting in with the sharp point of the arrow," he says.

Storm Ventures in Menlo Park also wants to fund four new startups this year, possibly in the networking hardware and wireless markets. If necessary, the firm will come up with its own ideas and recruit people to staff ventures, says Ryan Floyd, one of the partners. Those startups most likely will be based in Silicon Valley so Storm can keep in close contact with them.

That unorthodox approach of generating and staffing its own startup ideas has worked for Storm in the past. In 2002, it launched one of its own concepts--distributed Ethernet switches--with a Valley company named Airespace Inc. The word on the street was that there was no demand for the prospective product, earning the venture firm the sobriquet "Black Storm." Yet Storm and four other firms--Alcatel, Battery Ventures, Nortel Networks, and Norwest Venture Partners--sold Airspace to Cisco Systems for $450 million, after investing a total of $60 million in the company.

The need for data-security and government compliance also will keep the next round of startups busy, and odds are that the tech-centric Valley will play host to most of these ideas. Companies' IT infrastructures continue to mesh more closely with the Internet, and security problems will likely increase. "There's a lot of holes in the cheese," Winblad says, and opportunities "to build the things that never got built."

Voltage's founders thought so. In 2002, 20-year-old Kacker and fellow Stanford University students Matt Pauker and Guido Appenzeller wanted funding for their approach to data encryption. "We went up and down Sand Hill Road. We did the march," says Kacker, referring to the street between Interstate 280 and downtown Menlo Park studded with venture capitalists' offices.

Once the three co-founders secured Winblad and Morgenthaler funding, they wanted more seasoned leadership. "We said, 'We want an external CEO. We don't mind adult supervision,'" Appenzeller recalls. They hired Sathvik Krishnamurthy, 36, a former VP of marketing at Valicert, a supplier of secure file-transfer software, and general manager of the security division of Worldtalk Corp., which was acquired for its secure messaging system by Tumbleweed Communications. Terence Spies, a 36-year-old who did startup time at Asta Networks, came onboard as VP of engineering. Spies promptly advised them to do what may become standard operating procedure for startups in the next few years: Use offshore talent. They've hired half their engineers to work in the company's Palo Alto headquarters and the other half under long-term contract in India. That's a cost-savings advantage from the get-go, Appenzeller and Kacker explain over breakfast at Cafe Borrone, a popular spot among the Menlo Park tech set.

VCs demand that kind of operations savvy in addition to sound ideas before parting with cash. "VCs are a lot more careful about what they fund," says Robert Fanini, CEO of GroundWork Open Source Solutions Inc., which offers open-source software to monitor IT infrastructures and is backed with $11.5 million from Mayfield Fund and Canaan Partners. "I know a lot of people who are still struggling" to get funding. Before funding for Groundwork came through, Fanini had to face tough questions about how many customers the firm had, its market potential, and what sort of talent he'd assembled for a management team.

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