Silicon Valley 2.0 (Beta)

I’m in a Silicon Valley café with a stack of interview notes when I tune in to the conversation at the next table. ”We just got funded or, well, we had a million, but we got a few more�” The day before, I overheard two men and a woman review résumés for a start-up developing Web-based software for a pen computer. I almost expect the barista to throw in a second round of funding with my latte.

It’s a far cry from the sackcloth-and-ashes ambience of just four years ago, when out-of-work engineers camped out in coffee shops because they no longer had real offices. The energy, the ideas, and the money have all come back to Silicon Valley, and the only problem for a tech reporter is to find a representative sample. I chose five new-generation entrepreneurs—with electrical engineering or computer science degrees, or both—from four nascent companies.

You probably haven’t heard of any of them, in part because their start-ups are just coming out of ”stealth” mode, a time before product release when the company says little. All five technologists began putting their ideas together after the dot-bomb, and they recently got funding from venture capitalists.

But they traveled different paths to Silicon Valley, with different ideas, different technology, and different markets. Each firm had to be special, because venture capitalists no longer fund cookie-cutter businesses planning to make money in some undefined way off the Internet.

Aleks Göllü , cofounder of Pinc Solutions, started his journey in Istanbul. He arrived in the United States in 1983 and earned his bachelor’s degree in electrical engineering at the Massachusetts Institute of Technology. He moved to California in 1987 to work on his master’s degree and eventually his Ph.D. at the University of California at Berkeley, specializing in modeling of large-scale systems, particularly automated highways. Along the way, he worked at Oracle Corp. and Teknekron Communication Systems which, among other things, builds network management systems for telecommunications carriers. And from 1995 to 1997, he served on Berkeley’s research faculty.

By then, he says, he had figured out that he wanted to work at a start-up. Oracle, with 2000 employees when he left in 2000, felt too big. Teknekron, at 160 employees, had been a better size.

”I belong at a company where innovation is at its inception,” Göllü says.

In 1998, Göllü and two partners started a company, OtelNet, to develop a way of enabling telecommunications companies to offer their customers one-number service, that is, one phone number would reach their home, business, or cellphones, depending on the customer’s availability. The company ended up developing text-messaging applications that connected cellphones to the Internet. OtelNet raised US $3 million in its first round of financing and more than $10 million in its second round.

Göllü says that running an infrastructure company in the dot-com era was like riding out a storm. During the boom, he found it hard to hire people. Then, after the bust, the dream of a billion-dollar initial public stock offering blew away. Telecommunications Systems bought the company. Göllü stayed on for about a year and a half, then started Pinc in 2004 with a small investment from the Siemens Technology to Business Center, in Berkeley, Calif.

Pinc’s mission is to move the automated tracking of products beyond warehouse walls and into large distribution yards. Doing so involves mastering a higher degree of complexity than can be managed with today’s radio-frequency identification systems, the tags that identify everything from socks at Wal-Mart to lost pets. The reason: in big distribution yards, huge warehouses serve a variety of retailers, and hundreds of trucks come and go daily, dropping off shipments that are then sorted and shipped out to stores. Even today, such facilities still depend on a guy with a clipboard who walks around the parking lot, tracking goods.

Here’s how Pinc does the job: A distribution yard employee puts an RFID tag on each trailer when it enters the yard. Inside the yard, the trucks that hitch up to the trailers and tow them around are equipped with a tracking unit containing an RFID reader, a GPS device, and other off-the-shelf hardware that senses when a truck moves and in which direction. As the trucks go about their business, the tracking unit determines which tags are within range and transmits that information via 802.11g to a nearby Internet access point, which sends it on to Pinc’s server. Software on the server maps the position and movement of the trucks and trailers in the yard in real time. The manager of the distribution center can view the map and look at related data using a Web browser.

Pinc got an undisclosed infusion of capital in March from Sutter Hill Ventures. The company now has a dozen employees and has started service to its first few customers.

John Beatty, cofounder of Bix, moved to San Mateo, Calif., in 1997, fresh from a computer science undergraduate program at Brigham Young University, in Provo, Utah. As a software engineer, he says the only places on his radar screen were Silicon Valley and Redmond, Wash., home of Microsoft. He says he thought Silicon Valley would give him more interesting job options, so he joined Cambridge Technology Partners, a midsize consulting company with a number of offices in San Francisco's Bay Area. In 2001, he joined some friends who were developing Infrasearch, a peer-to-peer file-sharing product; one month later, the company was acquired by Sun Microsystems. Beatty moved over to Sun Laboratories, developing decentralized computing technologies, then joined BEA Systems, in San Jose, working to investigate the future of the Java language. In January, he quit to start his own company.

”I had assumed for a long time that I would start a company,” Beatty says. ”Being in Silicon Valley with the dot-com thing going on in the late ’90s made it seem like a fun thing to do. My plan was to get experience, get networked, get a financial cushion, and go start something.”

For a few months, Beatty worked alone, trying to develop a Web-based service that would apply the model of Amazon’s intelligent recommendations to media in general. For example, the service might recommend local events or movie openings based on a consumer’s taste in books. Beatty dropped that project in April when he met Mike Speiser, now the CEO of Bix, which had just incorporated and raised money—$6.5 million from Trinity Ventures, Sutter Hill Ventures, and smaller investors, including Stanford University.

Bix is developing what Beatty calls a ”talent platform” for the Web. It packages the American Idol model of talent competitions with viewer votes to enable anyone to run such contests online. Bix plans to bring in revenue through contest sponsorships, advertising, and consumer downloads.

Bix is testing its service now by invitation only. Its first public announcement was to be made by 1 August. After a few more months, and product iterations, Beatty expects to open the Bix service to the general public.

Scot Malloy , cofounder of Red Seal Systems, got his EE degree from Lehigh University, in Bethlehem, Pa., and worked at a variety of engineering companies in Pennsylvania in the late '80s and early ’90s. He developed hardware and software for hospitals and consulted for the aerospace and petrochemical industries. Then, in 1993, he moved to San Francisco to take a job with Documentum, a start-up in Pleasanton, Calif., that had developed a document-management system—a tool for securely tracking, storing, and backing up information. It was used, for instance, to manage the piles of paperwork involved in the development and approval of the drug Prozac.

”I had always wanted to come here,” Malloy says. ”Silicon Valley is where the action is for someone in technology.” At the time, his girlfriend, now his wife, also was eager to move back to the Bay Area.

”It was interesting times,” Malloy said. After a recession in the late '80s, Silicon Valley was starting to boom again. Malloy essentially got a degree in start-ups at Documentum, as the company went through a complete growth cycle, with an IPO in 1995, and then continued growth.

Malloy walked away in 1999 with enough money for a down payment on a house and experience that was priceless. ”That sealed the deal for me,” he says. ”From that point on, I wanted to do my own start-up.”

In 1999, at the height of the dot-com bubble, he joined Reactivity, a company in Belmont, Calif., that developed secure XML-based infrastructure products, and he did consulting for start-ups. A year later, Reactivity spun out a company called CenterRun, a product that enables customers to rapidly provision, track, and update their networked application services across many network devices, and Malloy went along as its first non-founder employee. But times were getting tough, and after 9/11, they got a lot more difficult. ”It was hard to get funding, hard to get customers to spend money on technology,” he says. In 2003, Sun bought the technology, which it now uses to distribute software to server farms.

Back in the early days of CenterRun, Malloy and the chief technology officer, Alain Mayer, had discussed Mayer’s idea of combining information from the various products that make up a network—routers, firewalls, and so forth—to identify problem areas that no network-security package could find using just a part of that data.

After the sale of CenterRun to Sun, Malloy and Mayer spent about a month and a half trying to find out if any other companies were providing such third-party data analysis. They determined that the field was wide open.

Malloy and Mayer met up with Brian Laing, an entrepreneur pitching a similar concept, and they made the rounds of the venture capital community.

”The VCs in 2003 were very cautious. Many were nursing along existing investments and weren’t opening new investments yet,” Malloy recalls. ”I kept telling myself that it was the worst time to be doing this, but we were convinced we had a good idea.”

Things started looking up in 2004. In the second half of that year, the company, now called Red Seal, got $14 million from Venrock Associates, Sutter Hill Ventures, and Leapfrog Ventures. For Malloy, the money came just in time.

”I went right up to the edge financially,” he said. ”My wife was none too pleased with me at that point, and I was about to step back from it and go out and get a job.”

In the fall of 2004, Red Seal leased office space and began buying equipment and hiring people. The company now has 33 employees, mostly engineers, and is about to add a sales and marketing staff. It came out of stealth mode on 12 June. Red Seal has developed a rack-mounted appliance, essentially a dedicated PC that can be installed in any large computing environment in half an hour. It can analyze the network on demand and spit out visualizations of security issues and suggestions for fixes. The company just started beta testing, and it plans to ship its first commercial products this month.

Matt Sanchez and David Lerman , cofounders of VideoEgg, graduated from Yale University in 2003 with electrical engineering and computer science degrees, $7500 in prize money from a business plan competition, and some cash invested by friends and family. They started a company called MediaLiquid with the idea of linking filmmakers to nonprofits that wanted to develop public service announcements. They couldn’t break even, however, and shut the company down in late 2004. They were then living in two one-bedroom apartments in New Haven, each sharing his apartment with 10 or 11 other people. Sanchez and Lerman were bringing in money by doing office temp work and substitute teaching, and they were living on instant macaroni and cheese.

They learned from their failure, deciding that it came because they couldn’t find a good way to let filmmakers send in high-quality video over the Internet. They joined forces with Kevin Sladek, another Yale electrical engineering graduate, and started VideoEgg, which produced a solution to the technical problem and applied it to the classified advertising market, enabling people to create video classifieds.

In early 2005, the three set out to find investors. In April, they got a small infusion from First Round Capital, which enabled them to hire a few more engineers and build the beta version of the Windows client part of their system. In September 2005, VideoEgg released its first product, a combination of software and hosting services that enables Web site owners to provide drag-and-drop posting of videos. By that fall the founders were spending more than half their time in California, where their potential partners and top developers were. They moved to San Francisco in December, and in January, August Capital agreed to put an undisclosed amount of money into the venture.

Today more than 25 Web sites use the service. The company has 20 employees in its San Francisco offices, and it is getting ready to develop version 2.0 of its product.

These success stories suggest that the money is flowing freely again in Silicon Valley. Still, it’s by no means as ”frothy” as in the late 1990s, says David Hornik, a partner in August Capital. Hornik defines ”frothy” as a lot of people with ideas and a lot of money being raised quickly on those ideas without a lot of evidence that they will bring in revenue.

But, Hornik says, it’s a lot better than it was from late 2000 to 2004. ”That was the financial equivalent of a nuclear winter,” he says. ”The investors were waiting to see how everything shook out, and entrepreneurs were waiting to see if it made any sense to start a new company.”

Pinc’s Göllü adds that the dot-bomb not only dried up the supply of venture capital but also the demand for it. ”Sure, there was the crash, and money lost,” he says. ”But it wasn’t just that VCs didn’t want to invest. The entrepreneurs weren’t willing to push. Everyone had worked so hard, and they were tired.”

Beatty recalls that in 2002 venture funding was dead. "If you wanted to do something in consumer Internet, good luck, come back when you have a million users,” he says.

PricewaterhouseCoopers and the National Venture Capital Association confirm those subjective memories of Silicon Valley: the low point was indeed 2002 to 2003, both in terms of the number of companies funded and sheer dollars invested [see " Ups and Downs"]. The organizations consider Silicon Valley to include the entire Bay Area as well as the nearby coastline.

The shift came in the summer of 2005. ”I don’t know if it was that more ideas started coming out of the woodwork, or if people had wrapped up all their past investments and were looking again,” says VideoEgg’s Lerman, ”but all of a sudden there were a lot of ideas and a lot of new companies that started publicly announcing that they had gotten funding.”

But the best times, says Tench Coxe, a managing director of Sutter Hill Ventures, were pre-bubble: ”You didn’t have the wage inflation then that you have now. The rest of the world didn’t know how much wealth could be created by technology. People just thought those Silicon Valley guys were weird, spending all that time hanging out with computers. And that was a nice place to be.”

Now, Coxe says, although money is available, the competition is brutal. ”As soon as you see a good idea, someone starts a company,” he says. ”MySpace started, and there were immediately 15 MySpace knockoffs out there.”

So, although Coxe says that, as a venture capitalist, he has money available to invest in interesting ideas, he worries ”about the defendability of an idea.”

Is Silicon Valley still a mecca for entrepreneurs? August Capital’s Hornik says he thinks it is, although he, too, defines Silicon Valley expansively, to include most of the Bay Area. ”When I began discussing the potential of financing VideoEgg with its founders in New Haven,” Conn., he says, ”my first question was, When are you moving?”

Coxe disagrees, saying, ”It’s a wonderful place to live, but it’s the highest-cost place on the planet to produce technology.” Coxe advises entrepreneurs to stay where they are if the local engineering talent is cheap. ”We just financed a firm in Bangalore and Mumbai” in India, he says. ”I’m happy when I find deals in Florida or somewhere else off the beaten track—there are talented engineers there, and you are more likely to hold on to them.”

Because so many companies are competing for talent in the Bay Area, some businesspeople say an entrepreneur is better off finding, for instance, the two Flash computing experts in New York City rather than fight over the nine in the Bay Area. But Hornik doesn’t agree.

For new media, in particular, he says, ”most of the innovation is taking place within four blocks of the baseball stadium [AT&T Park] in San Francisco.” To have the best shot of success, a new media company needs to be close by, he says.

For infrastructure software companies, he adds, the hot spot is a bit south, around San Jose. The East Bay, he says, draws enterprise application companies, of which Pinc is an example.

Göllü of Pinc says it indeed costs more to develop products in Silicon Valley than it does elsewhere in the world, ”but the experienced people are here.” Pinc makes up some of the cost differential by hiring students from the University of California at Berkeley to do development work.

Entrepreneurs do seem to feel more comfortable being surrounded by their peers. ”Being a start-up in New Haven, you are all by yourself trying to figure out what you’re doing,” Lerman says. ”Here you’re in the middle of a big ecosystem.”

”Venture capital is available around the world,” Bix’s Beatty says. ”There are tech teams in China or India or Eastern Europe, but here you can have cohesive central development, and the investors can be involved because they are down the street. There is still a kernel of critical mass here that doesn’t exist anywhere else.

”There is no better place to be than right here, right now.”