New investors scramble to find next Alley champions Ex-corporate chiefs, Wall Street angels pour in their money; are they too late?

by Mark Walsh

May 10th, 1999

When former Liz Claiborne Inc. Chief Executive Jerome Chazen started his own investment firm three years ago, he planned to focus on traditional consumer businesses. But now he has stakes in two Silicon Alley start-ups, and PassLogix Inc., and is looking at other Internet deals. "I've come to the conclusion the Internet will revolutionize the way goods are going to be distributed," says Mr. Chazen. From former Fortune 500 executives such as Mr. Chazen to high-powered investors such as Leon Black, Silicon Alley is luring a new crop of venture capital and angel investors who want to get in early on the next hot company. They are pouring money into the Alley's concentration of Internet services, electronic commerce and content companies, and boosting the New York area's technology-sector investment to record levels. Last year, the region drew $496.8 million in high-tech venture funding, up 15% from 1997, according to PricewaterhouseCoopers. Through the first three months of 1999, private Internet deals amounted to $238 million.

Capital stream

This investment is a boon to local entrepreneurs, providing a continued stream of capital to spur the growth of new ventures. But the wads of money may also raise the risks. Venture capitalists are now competing hotly with each other for the most promising companies, raising the cost of some deals to stratospheric heights. And the influx of new players, some of whom are inexperienced in the Internet, increases the likelihood of bad investments. For many, though, the potential upside of the Internet is an irresistible force. In New York, the wave of sizzling Internet initial public offerings since late fall has helped to turn up the heat under the private equity market. Newly public companies, such as and EarthWeb Inc., with low revenues and no profits have half-billion-dollar market caps. Now, an increasingly diverse group of private investors is betting that promising Internet companies, such as PassLogix, will become IPO stars, too. Venture capital firms focused on early-stage investing in Internet businesses here have at least doubled in the last year. Among the latest is Oculus Media Inc., started by venture capital veteran Francine Sommer. Beyond saying that she is concentrating on backing Silicon Alley start-ups, Ms. Sommer is tight-lipped about her investment strategy, because the company hasn't formally launched.

Smart to be diversified

Former Internet executives and entrepreneurs are turning financiers as well. One is former Chief Financial Officer Stephen Ellis, who left the troubled company in November to start his own Internet-focused venture firm, FSA Capital. Having seen the fortunes of Biztravel fizzle, he wanted to improve his odds in the Internet sweepstakes. "It's foolish not to be diversified across a bunch of different opportunities in this space," he says. His firm has taken stakes of between $500,000 and $2 million in five Internet start-ups, including Manhattan-based Mediformatics, which makes a Web-based medical claims processing system. Like other executives turned backers, he plays a hands-on role as a board member and adviser to the fledgling companies. The field of new venture players isn't limited to those with Internet expertise, as reflected by Mr. Chazen. He concedes that his Internet conversion was influenced by his 38-year-old son, who serves as Chazen Capital's managing director and is an enthusiastic on-line buyer. "He understood the Internet before I even knew what it was," says Mr. Chazen.

Acquired affection

Prominent hedge fund manager Leon Black is also learning to love the Internet. His Apollo Management Inc. last month put $75 million into interactive agency Rare Medium Group Inc. to help it launch its own venture investing arm. Until now, Apollo's $3.5 billion fund had stakes in a variety of traditional businesses, such as Vail Resorts, Samsonite Luggage and Berlitz Language Centers. The impetus for the Rare Medium deal came from sitting through board meetings of portfolio companies where the issue of defining a Web strategy kept recurring, says Apollo partner Andrew Africk. Also part of the trend are so-called angel investors, typically wealthy individuals who are former executives or entrepreneurs. In New York, that group now includes investment bankers and other Wall Street professionals who have ridden the bull market to riches. "Everyone in the financial industry has made a lot of money in the last seven years," says Greg Arnold, president of PassLogix. He is aware of as many as 40 Wall Street professionals who are making initial or early-stage investments in Alley companies. Angel investing, long seen as lacking in the New York market, has also become more institutionalized in the last year. For instance, Wit Capital's $20 million Dawntreader Fund, started by Wit Chairman Bob Lessin, and Silicon Alley Venture Partners, launched by AdOne founder Steve Brotman, are both focused on seed funding. "We can see the hype in the Internet stocks is definitely trickling down to early-stage companies," says Ed Sim, a Dawntreader senior vice president. The hype is also driving up company valuations, boosting the risk for venture investors. The flood of money into the Alley may also lead to more bad deals as less savvy investors move quickly to cash in on Internet mania. "There's a lot of money out there, and I think you will see a lot of missteps eventually emerge," says FSA Capital's Mr. Ellis.

Skittish angels

More experienced investors are shying away altogether. Longtime angels are skittish about plunging into Internet ventures, according to Ellen Sandles of Manhattan-based Sandles Capital Resources, a matchmaking service between angels and entrepreneurs. "They feel the bubble is going to burst at some point," she says. Veteran Alley venture capitalists agree that some new players wind up getting burned. But they note that the quality of start-ups, along with the quantity, has risen in the last few years. Says Graham Anderson of Euclid Partners, "We're seeing higher-quality managers as people leave more established positions to take the risk of starting an Internet company."