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California dreamin?

VCs are still thinking big in Silicon Valley, but they're placing more bets outside information technology

PALO ALTO, Calif. -- Silicon Valley venture capitalists were grudgingly coming to terms with a sober new era, devoid of irrational exuberance, when they were jolted by the Google juggernaut.

Only a lucky few venture backers, led by Kleiner Perkins Caufield & Byers, reaped giant gains from Google, which raised $1.67 billion in an initial public offering last summer and more than doubled its share price since. But the Google IPO gave a psychological boost to investors in the risky high-tech start-ups that have long defined the Bay Area business scene.

''It reminded us that you have to be visionary, you have to take chances, that dreams do happen," said Kenneth P. Lawler, general partner at Battery Ventures in San Mateo, Calif. ''You don't want to get to be so conservative, so analytical that you can't find a way to take a crazy chance every once in a while on a couple of super smart guys with a wild idea and visions of glory. You just have to go for it."

''What it shows is the entrepreneurial spirit is alive and well, and even entrenched companies are vulnerable," said Walter G. Kortschak, managing partner at Summit Partners in Palo Alto. ''There's innovation. There's opportunity for improvement in a variety of sectors."

And venture firms in Silicon Valley, the heart of US venture capital investment, have continued to put their money to work in a post-bubble environment that is at once less certain and more competitive, especially in their own neighborhood. Even as venture investing slowed 7.9 percent nationally in the first quarter of 2005, and tumbled 19.2 percent in New England from the same period a year ago, investments from Silicon Valley venture capital firms fell off just 2 percent.

But the investment mix has changed markedly from the boom years of the 1990s, when information technology drove economic expansion and early-stage start-ups were the rage. The start-ups raising money today are not only capitalizing on rapid Internet adoption, like Google, but also using technology for biomedical, environmental, multimedia, and other applications. And more mature later-stage companies are grabbing a larger chunk of the dollars.

Familiar high-tech sectors such as networking, security, enterprise software, and wireless communications are still drawing funds. But so are emerging areas ranging from nanotechnology to clean energy, from open source software to business process outsourcing. And investors are backing traditional businesses, like consumer products and financial services, that use technology for competitive advantage.

''The big megatrend that I've been investing in is really use of the Internet for the basic fabric of our business and personal life," said J. Sanford (Sandy) Miller, a US managing director of 3i Group in Menlo Park, Calif., who backed the Vonage broadband phone service.

Indeed, the move toward ''convergence" -- of hardware and software, information and entertainment, technology and healthcare -- was a theme cited repeatedly in an April 26 roundtable of Silicon Valley venture capitalists organized for the Globe by the National Venture Capital Association. The roundtable was hosted by Summit Partners in Palo Alto, and, like Summit, most of the firms represented had operations in both the Silicon Valley and Boston/Route 128 technology hubs.

The convergence trend, and the focus on consumers, stand in contrast to the 1990s, where the most profitable niches in California and New England were selling software and telecommunications gear to corporate data centers. But those niches are being squeezed today, with businesses cutting back on spending, Kortschak warned. ''Selling software to enterprises has become a tougher proposition," he said.

While many trends can be seen on both coasts, Silicon Valley venture capitalists who spend time in Boston see some differences: a venture industry in the Valley that invests more than twice as many dollars as New England, the nation's second-largest venture market; a less clubby environment here in the West, with more tolerance for failure; a greater emphasis on consumer-oriented investments, from digital media to personalized medicine; and a higher share of start-ups by immigrant entrepreneurs from India, China, Israel, and Eastern Europe, including many who have set up offshore operations in their native countries.

''Culturally," suggested Battery's Lawler, ''California has had in its history the Wild West and the Gold Rush mentality. People are willing to take a risk here and turn it into something great. People like Andy Grove arrive without a penny in their pocket and build something up. That's the way the Valley works."

Despite the drop in venture investing in the first three months of this year, venture capitalists here say economic conditions are the healthiest they've seen since the pre-bubble days. But the more candid VCs confess to some nostalgia for the 1990s technology boom, its breathless hyperbole and overheated valuations notwithstanding. ''It was fun," said Steven N. Baloff, general partner at Advanced Technology Partners in Palo Alto. ''Even my wife says, 'Bring back the bubble.' Of course it was unrealistic. But we were the center of the world."

Still, few predict a return to those heady days any time soon. While the Google experience proved Silicon Valley still can spawn a technology highflier, its IPO is no longer the ''exit" model venture firms envision for the bulk of their portfolio companies. The more common way to cash out of their investments is through mergers and acquisitions, which have been on the rise over the past year. One reason: Big technology and pharmaceutical firms, having scaled back on their own research and development, are looking to start-ups for innovation.

''We've had several companies contemplating IPOs that were preempted by big pharma," said William Greene, general partner in the South San Francisco, Calif., office of MPM Capital, a venture firm specializing in healthcare. ''Consolidation in the pharmaceutical industry has built gigantic firms that are trying to feed growth expectations. It's literally impossible for them to continue to grow at the same exponential rate that Wall Street analysts have expected them to organically. They must acquire. . . . And they're looking downstream to acquire technology."

Silicon Valley venture capitalists increasingly are scouting outside their region, to Southern California, Europe, and even New England, for investment candidates. One factor is a proliferation of new venture firms flush with cash from limited investors, such as wealthy individuals and universities, eager for higher returns. ''If we see a growing, profitable technology company in the Valley, typically it's quite a competitive situation," Summit's Kortschak conceded.

Still, the Valley's risk investors continue to hunt for the next Google. ''The venture business is about the winners," said Oren Zeev, partner at Apax Partners in Menlo Park. ''If you have a winner like Google, it almost doesn't matter that you have five other losers. If you're in the venture business, you have to be willing to make crazy bets."

Robert Weisman can be reached at

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