THE NEW NEW ECONOMY
There is an abundance of ideas in the
BLAME START-UPS: THEY'RE NOT
SPREADING WEALTH OR JOBS -- AND THEY MAY NEVER
Just over a year ago, former venture capitalist Andrew Anker took
a senior management job at Six Apart, a high-profile local start-up.
His confidence about Silicon Valley's impending resurgence was so
strong that he predicted, in an interview with the New York Times,
that the area was 12 to 18 months away from a development like
Netscape's initial public offering -- the seminal event that
unleashed the Internet revolution and the unprecedented wave of
IPO-fueled wealth creation that came to be known as the Internet
The spectacular Google initial public offering, which dwarfed
Netscape's, has come and gone. Scores of hot start-ups have sprung
up around the valley. But on the eve of the 10th anniversary of the
Netscape IPO on Tuesday, a new Internet revolution or bubble appears
as remote as the prospect of a business wrapping its identity around
a sock puppet.
``I may have been off on the IPO side,'' Anker now says. ``I
wasn't off on the excitement side.''
Anker's rethinking captures the paradox gripping the valley. Yes,
there's excitement -- there are lots of innovative ideas and
start-ups, and lots of venture capital flowing into them. The
valley's innovation machinery is humming again.
``It's an excellent time,'' says Mitchell Kertzman, the former
CEO of Sybase and Liberate, now a venture capitalist at Hummer
Winblad. ``We are seeing really good entrepreneurs, really good
technology and really good innovation.''
But some of the forces that propel those innovations from simply
cool ideas into economic drivers for the entire region are
In short, start-ups aren't lubricating the valley as they have
historically: They aren't creating the broad-based wealth or
employment they formerly did. And they may never again. Partly
that's because of post-bubble wariness toward initial public
offerings. But it's also because of a far broader, and probably more
permanent, trend -- the shift of technology jobs overseas.
Even the good news is tempered: Some veteran venture capitalists
worry that, once again, too much investment money is flooding into
the valley. If true, it could lead, in an eerie reminder of the late
'90s, to the funding of flimsy ideas, followed by a slew of
For the moment, though, the good and the bad of the bubble remain
a distant memory.
Despite a sizzling housing market and crowded shopping malls --
and despite the energy among entrepreneurs -- there's that lingering
feeling that the valley has lost its punch. Indeed, nearly four
years into the national economic recovery, Santa Clara County is
still down about 200,000 jobs -- roughly one in five -- from its
bubble heyday. The 20 percent decline in jobs is the biggest for any
metropolitan region in America since the Great Depression.
What could spark a resurgence? The region functions best with a
smooth, three-step process involving ideas, capital and a way for
that capital to multiply -- or in investor lingo, a ``liquidity''
Here's the ideal: First, smart engineers and entrepreneurs come
up with new technologies and ideas. Then, venture capitalists, who
raise money from eager investors, provide the entrepreneurs with
capital. Finally, initial public stock offerings, or alternatively,
acquisitions, allow that capital to multiply. The riches from these
``liquidity events'' are distributed mostly to company founders and
venture investors, but also to employees, when they cash in stock
options. As long as no one element gets out of whack, the cycle
Ripples from Netscape
Clearly, the Netscape IPO pushed things off balance. Its most
profound effect was to dramatically lower the bar for liquidity
events. All of a sudden, just about any company could -- and did --
go public. Investors who poured dollars into dumb ideas that were
losing money made spectacular returns. By 1998, the valley was in a
It all came to a sudden halt when the stock market began a nearly
three-year downward spiral in the spring of 2000. Companies folded.
Thousands of investors lost their shirts. Yet others, including many
venture capitalists who had unloaded shares before the bust, enjoyed
untold fortunes. That has sustained the mystique about outsize
returns in the venture industry.
The result is that venture capitalists continue to collect money
from pension funds, endowments and other large investors seeking to
diversify their portfolios. In addition, investors from Europe and
Asia are joining the parade. Says Jim Breyer, one of the valley's
most respected venture capitalists: ``There is far too much
After the stock market crash of 1987, the number of venture
capitalists and venture-capital funds declined. But after the Nasdaq
crash of 2000, the numbers stayed roughly the same, says Breyer, who
recently completed a stint as chairman of the National Venture
There are solid opportunities in such sectors as network
security, digital media technologies, data storage, life sciences
and consumer Internet services. But Breyer and some others say the
valley may be launching too many ``me too'' companies. In 1995,
before the froth, there might have been two or three companies going
after a hot segment of the networking market, Breyer says. ``Today,
there might be a dozen.''
Flush with money, venture capitalists have been investing in
young Bay Area firms at a steady rate -- $6.7 billion to $7.7
billion annually -- since 2002. It may seem like a paltry sum when
compared with the $33 billion invested in 2000 at the peak of
dot-com mania. But it's far higher than any year before 1999. And
the amount flowing from investors into venture-capital funds
continues to grow, up more than 88 percent nationally, to $6.1
billion, in the most recent quarter compared to a year earlier.
In contrast, IPOs remain rare, held down by skeptical investors
and tougher legal and financial hurdles. There have been only six
IPOs so far this year in the valley, compared with 67 in pre-bubble
1996 and 78 in 2000. To be sure, many start-ups are being acquired.
And the lack of overheated IPOs, especially among companies with no
profits, has pluses: It has reset the expectations of entrepreneurs,
who no longer seek overnight wealth.
But it's hard to ignore the seeming imbalance between investment
and potential returns.
``A huge inventory of private companies is being built, and if we
don't have liquidity events, we'll start to see problems,'' says
Andy Verhalen, a partner at Matrix Partners. ``Companies can only be
supported by private investors for so long.'' In other words, the
valley could again be populated by the ``walking dead'' -- as
companies facing guaranteed extinction were known in the aftermath
of the bubble. Then, many venture capitalists, lacking big hits,
might pull back.
Even if venture capitalists and company founders do manage
to get rich when some hot start-ups go public or get acquired, one
part of the valley's ecosystem remains troubled. For a healthy
economy, the wealth needs to be spread around, not just with stock
options, but with jobs.
That's a task for start-ups, and this time around, they don't
appear to be up to it.
Indeed, the area may be known the world over for its Apples and
Oracles, Intels and Ciscos. The giants anchor the valley's economy.
But historically, it is start-ups, not established companies, that
create the bulk of new jobs here.
That's likely to be truer than ever now. The valley's top public
companies have learned to do more with less. They are just back from
a year of record profits, yet they have added virtually no jobs in
the valley. Some, such as Hewlett-Packard and Sun Microsystems, are
still shedding workers. And start-ups have not filled the gap.
One reason may be that many start-ups, especially in the consumer
Internet sector, don't need as many workers. Consider Six Apart, the
company that Anker joined. Its first product, a tool for blogging,
was built entirely by the husband-and-wife team that founded the
company. Soon after the software was uploaded to the Web, thousands
of people began using it. That quick leap from invention to market
acceptance may seem common now, but before Netscape it was unheard
``Now to start an Internet software company, you don't need to
hire 500 people and build a direct sales force,'' Anker says.
Overseas hiring has also played a part in keeping local
employment growth down.
Venture capitalist Verhalen estimates that 70 percent of the
companies his firm funds have at least some of their engineering,
quality assurance or support functions offshore.
The impact could be significant.
From 1990 to 2001, start-ups created 258,700 jobs, according to a
study by the Public Policy Institute of California. During the same
period, established firms that were around when the decade began
lost 120,500 jobs.
That creation and destruction left the valley with a net gain of
If just 20 percent of start-up employees were to be hired
overseas, a new boom of 1990s magnitude -- unlikely even in the
rosiest of scenarios -- would leave the valley with a net gain of
only 87,000 jobs in a decade. In a lesser period of innovation and
expansion, start-ups may not be enough to make much of a
contribution to employment growth at all.
The burst of the bubble, though painful, has helped stabilize an
economy and investment climate that was far too frothy to be
sustainable. With a strong lineup of marquee companies and nearly a
third of all new venture-capital money nationwide still being
invested here, there's no risk of the area going bust anytime soon.
But the valley's New New Economy is stingier: Don't look for
wealth to be spread as it was in the bubble -- or even in the
healthy years before.MIGUEL HELFT (firstname.lastname@example.org) is
a Mercury News editorial writer. He has been covering the tech
industry for nearly a