Milestone Group Quarterly: October 2007
Articles
Investment Viewpoint:
Eric Benhamou of Benhamou Global Ventures
Milestone: Tell us about Benhamou Global Ventures.
Benhamou: Benhamou Global Ventures is an investment company I’ve operated over the last 4 years or so that helps finance exciting entrepreneurial startups. My investment model is a little different from a classical VC in the sense that this is not a fund with limited partners. My mode is to invest narrow and deep, so I tend to be very active with the companies I work with. And by active I mean, of course, that I don’t just write an investment check. I am active on the board and with the CEO and founders. Often, I’m asked to serve as Chairman of the Board to help provide governance structure for the company. I tend to invest only in companies where I feel I can make a meaningful contribution. I’ll typically not invest outside of my domain of expertise, but only where my relationships can be leveraged and my technology or business knowledge are still current and relevant. What’s most important for me is to achieve a balance between learning and teaching.
Milestone: What do you mean by learning? It’d seem as if there’d be few surprises for you, given your experience.
Benhamou: I want to be able to learn from the founders, the CEO, and my colleagues on the board. And, I’m hoping to be able to contribute the lessons and experiences I had in my own career. That’s also why I’ve chosen to teach at INSEAD; it puts me in touch with very mature, very smart students coming from all over the world. I always look forward to spending time with these students and I often feel like I learn more from them than I teach them.
Milestone:You’ve been at this for a while. Thinking of the Silicon Valley as an ecosystem, how do you think things have changed over the years? What have been those significant disrupters and what have been the significant contributors to the system, over the last five years or so?
Benhamou: I’m working on answering this question in the context of a broader project by serving on the Computer Science and Technology Board of The National Academy over the last several years. We have been researching the health of our ecosystem not just in the Silicon Valley, but in the US more generally.
You can compare the environment today to what it was like in 1995 when Netscape went public and the Internet gained broad awareness by the public.
I was on the board of Netscape and I had participated in the IPO and I remember it vividly. At that time our ecosystem was viewed as extremely healthy, extremely competitive and second to none in the world. There have been quite a few changes in the last 12 years or so years, and we still have a really positive ecosystem. But, I would say that there are three things or four things which have really changed and which have diminished the strength of our competitive advantage.
The first is that we have seen the globalization of high tech markets accelerate, both in terms of labor markets and financial markets. We’ve seen in particular the emergence of China and India as technology powerhouses and as legitimate markets in their own right. So, this has dramatically changed how we think of the world; when you build a technology company, you can no longer afford to ignore markets outside of the US. Not only that, but even as a young startup unless you take advantage of the development and manufacturing capabilities that exist in China and India, you are unlikely to be competitive.
Milestone:Right. The other major change to the ecosystem is that is has become higher friction. And by this I mean that we have really thickened the regulations and the laws that govern the creation and the growth of companies. Congress enacted the Sarbanes-Oxley Governance Reform Act, which has affected smaller companies unfairly, and which, frankly, was passed with little understanding of the cost that is required to comply with its provisions.
So, the pendulum swung way too far. Sarbanes Oxley demands more and more from CEO’s to justify their investment decisions in terms of return on investment, but there’s no corresponding requirement on the regulators who enforce it.
We’ve gone to a corporate culture that basically tells people that its okay to be conservative, that it’s okay to worry about the downside more than the upside, and its okay to not think about aiming for the moon. The conversation in the boardroom has shifted, but not for the better as far as the entrepreneur is concerned. A lot more time is spent ensuring that we have met both the spirit and the letter of the compliance requirements of the law rather than ensuring we have the most competitive business strategy.
It’s not just Sarbanes-Oxley. Our ecosystem suffers from laws which enable those with patents filed to hold companies ransom, even though they (the filer) have built absolutely no product, tested no market, and satisfied no customer from the patent. We call these companies “patent trolls”. I think there is a cost that we pay in terms of legal defense and time capital, the time it takes to defend yourself in court benefits large companies, not young innovative companies.
Milestone: So globalization and friction are the disrupters in the system?
Benhamou:I’d add one more to the list. It turns out that right now, because the industry has rebounded and it’s growing, we are once again limited by the talent pool we have access to. We’ve made it very hard to keep the foreign graduates who come to our universities and receive masters and Ph.D.s in Computer Science and Electrical Engineering. Our immigration laws and our visa quotas are such that, for example, down the street from my office at Stanford University, where more than 50 percent of the Ph.D. candidates this year are foreign born, the majority of graduates will end up going back to their home countries - not by their choice, but because they can’t stay.
So, there have been many people who have proposed stapling a green card or a work visa to these advanced degrees when they are awarded. And, that’s something that makes all the sense in the world, but we are still not doing it. If we can’t get these people to stay here, to work here on US soil, then we will follow them wherever they go, and therefore we will move the jobs elsewhere. So, our ecosystem shifts as a result of that.
Milestone: Can you take us back to the early days of Palm? It's hard to think of a bigger story in tech during the 2001 - 2003 time frame. What did it feel like to be at the helm of one of the most talked about companies of that period?
Benhamou:Well, it was a bit exhilarating and scary at the same time. Exhilarating to see that company almost become an icon of the high tech world and that technology enjoying such a rapid rate of adoption. It was also a bit scary when we took the company public. We announced our intention in late 1999 and ended up taking it public on March 1, 2000. We went out two or three days before the all time peak of NASDAQ, when the stock market was at its maximum level of frothiness. The hard thing to do at the time as a CEO was to know full well that a bubble was forming and that the company could not possibly be valued at such an exorbitant level. But you have no choice in the matter; you cannot tell investors that they should pay less for your stock.
You just have to ride it out and brace for the fall, which inevitably happened. And of course the fall was worse for Palm because we happened to have been born at the peak of the bubble. At that time I was the chairman of the company and had recently recruited a CEO who started when the company was still rapidly expanding. Six months after he came on board, the company was in free fall and he struggled to navigate us through that phase. I ended up having to reinsert myself in the company to help turn this situation around, which we barely managed to do.
During that time I had a very strong executive at my side, Todd Bradley, who since moved on to lead the PC business at HP and has accomplished a similar and even more dramatic turnaround there.
Milestone:Now Palm (and 3Com) has been acquired by a private equity firm. Is there a trend where big companies are going into private hands?
Benhamou:It goes to the issue of friction in the ecosystem. Basically, public equity has become more expensive than private equity, and therefore people are tempted to rethink their capital structure.
Even though Palm helped to create the smartphone market, it is now one of many players and has to fight tough competitors for share. The company has to reignite another level of innovation.
The deal will help bring people like Fred Anderson and Jon Rubenstein in key positions of the company. And, we will radically improve the capital structure of the firm. I think shareholders will be handsomely rewarded for it when the transactions closes, but also over time as these newer players have a chance to weigh in on the strategy of the company and improve its execution.
3Com is a similar, but slightly different story in the sense that it’s a full privatization with a very large private equity firm, Bain Capital. 3Com of course has large assets in China, and our former joint venture partner Huawei will also take a minority position in the private company.
Milestone: You mention the tech bubble of earlier in the decade and having a sense of the bubble was about to pop. What do you think needs to be learned out of that time? Has it been learned yet?
Benhamou:Well, it was a collective loss of common business sense. The business plans that were funded, both in private and public companies, just didn’t meet the basic standards of return on invested capital. When you start losing that discipline that’s when bubbles get formed.
I don’t perceive this same lack of business discipline happening now. The high tech sector is in a pretty healthy state. There are plenty of very good companies with very sound business plans, and valuations are still at fairly reasonable levels. The other thing to keep our feet on the ground is the amount of funds available to invest – it’s about the same, likely even less, than it was in 1998.
I have kept tabs on the venture capital statistics published by outfits like NVCA and others. We are investing about $27 billion of venture capital in this country, or about the same as in 1998. But obviously, if you correct for inflation it’s actually less, and a larger percentage is going outside of the US. And now clean tech is contending for these same venture dollars. So, IT has a smaller share than it did then. I won’t be surprised if the amount of venture capital that we invest in IT today is only two-thirds of what we invested ten years ago (in constant dollars). This is basically the speed governor that prevents bubbles. If venture capital amounts had tripled, then it would be very hard to keep bubbles from forming, but I think our current state is basically in pretty good shape.
Milestone: What are the megatrends affecting venture capital today? Where is the money flowing and what are the areas of interest?
Benhamou:The business of venture capital is very different today than it was 10 or 12 years ago. There is much less of it relative to other forms of capital, largely because returns have come down. Plus, more exits today are through trade sales as opposed to IPOs, so this reduces the average return achieved by venture capitalists.
So, basically with rates of return coming down, venture capital is a less desirable asset class relative to others. And the allocation of this venture capital, as I suggested, has changed fairly dramatically. You now have the US versus international dimension. I see many of my colleagues in this industry who invest in Asia, in China, in India, in Israel, and even in Europe. So, there is more of this money that actually gets invested elsewhere. And then you have the clean tech versus high tech mix that has changed.
Milestone: What’s your view on clean tech? Is it going to continue to put pressure on early IT investment over the foreseeable future?
Benhamou:Well, I think it’s absolutely real because there is an area of gray between high tech and clean tech. As Chairman of Cypress for the last 14 years, I’ve been privileged to be associated with the birth and growth of a company called SunPower. We got involved with SunPower, mostly thanks to TJ Rogers' gut instincts about the future of solar technology, long before the current interest in clean-tech.
We bought this technology and this company in the 2001 time frame. We thought this might help diversify the semi-conductor business of Cypress. Today, SunPower (the subsidiary) is worth more than the parent company, Cypress. This is a clear example of a real company delivering breakthrough products that not only solve a problem, but also deliver societal benefits. So, the capital that goes into companies like this is fully justified by a solid return on investment.
Milestone: What about the strength of the US Dollar (or weakness in the dollar, as the case may be)? We hear that a weak dollar means more foreign investments in hard assets (e.g., real estate). But what about early capital investment? Does a weakened dollar have any effect?
Benhamou:Well, my observation is that we don’t spend a lot of time discussing the strength of the dollar or the weakness of the dollar in the boardroom, as there is not much we can do about it. But, it doesn’t seem to be affecting the success or failure of young companies. It clearly has to be managed, it influences your real cost of labor. For example it makes offshore labor perhaps less attractive relative to a strong dollar scenario.
Mitigating this is the fact that products largely designed in the US are still going to be more attractive to, say, European customers because of our weak dollar. There are very few manufactured high tech products that we buy from the Europeans.
Milestone: You've been very vocal on the need to devise an on-line system of medical records. What's your reaction to Microsoft's recent announcement that they'll build a massive repository of personal medical information?
Benhamou:I have seen the Microsoft announcement, and obviously Google made a similar announcement a little while ago. Clearly these two companies are determined competitors. I think it’s generally good that these systems are being provided, but I doubt that the Microsoft system will have a meaningful impact overall. The healthcare problem is far more complex than Microsoft’s approach can possibly address.
The fundamental issue with healthcare technology is that the incentives are totally misaligned. The people that need to make investment in these technologies don’t have the required incentives because the benefits will accrue to society at large, not to themselves. In order to get a small doctor’s office on-line, it’s not just a technology investment, there is time and training involved in managing these records. (The software can’t possibly be so easy to use that it takes no training.) It will take training, it’ll take maintenance, the software will occupy disc space and storage, and it’ll take time to protect the data.
What we try to do at Smart Health (a non-profit group) is to play the role of neutral third-party broker. We’ve brought together representatives from the provider community, the insurance community, the employers, and the doctors. When a patient health records system or a claim adjudication system is put in place, we can administer it in a trusted fashion and we can provide benefits to the various stakeholders proportional to their investments. That way we avoid the lopsided situation where one stakeholder has to make early investments and the benefits accrue to someone completely different along the food chain.
In this country many people see the third-party as being the government. And that leads to resistance because it’s not consistent with our cultural value of private enterprise. Smart Health is not the government, we are nonprofit and our membership is comprised of political leaders, business leaders, and non profit leaders to fairly represent the community. And, this is what gives us a reasonably good reputation, good enough to be able to make this work here.
Milestone: Any sense on the global outlook for the software business based on what you’ve seen in your travels?
Benhamou:Well, I don’t consider myself a software specialist. Recently I’ve dabbled in Web 2.0 companies and I’ve been amazed to see how software development has changed, particularly in quickly delivering a service with a fairly compelling set of capabilities in a short amount of time. So, I believe that Web 2.0 software that takes full advantage of the Web capabilities has inherently great return on investment characteristics- the investment is a fraction of what it used to be and the capabilities that you unleash are extraordinary. So, I’ve seen a lot of business plans of software companies who are building Web 2.0 architecture that solve business problems.
Milestone: We always ask this question: Is there a deal you may passed on which you'd like to have as a "do over"? Any one company come to mind?
Benhamou:Oh, there are probably a couple that I had a chance to invest in, but I didn’t. In that case, it was mostly that I was running out of time, not so much because I didn’t have the capital or had reservations about the company.
There are a couple of those in the communication space, perhaps. I did not take part in Infinera, which went public after maybe 6 years or 7 years toughing it out after having raised nearly $200 million in venture capital; this is a company which required a lot of persistence and belief that the technology was eventually going to enjoy great return from the market. So eventually, for the persistent investor, it did pay off with a spectacular IPO this past summer.
Another one, which may or may not payoff, but it’s a space which I find exciting is MetaCafe, They play in the same space as YouTube but the way they organize their media content ensures that the junk is pushed down and the high quality stuff rises to the surface more quickly than anywhere else. So, this is a company which Benchmark and Accel invested in. I was tempted to join the syndicate, but I just didn’t have the time to allocate to it in my portfolio.
Eric Benhamou is chairman and CEO of Benhamou Global Ventures, LLC. Benhamou Global Ventures, started in 2003, invests and plays an active role in innovative high tech firms throughout the world. Mr. Benhamou is also the chairman of the board of directors of 3Com Corporation and Palm, Inc. He is an adjunct professor of Entrepreneurship and Family Enterprise at INSEAD. He is also a visiting professor at Ben Gurion University. He served as chief executive officer of Palm from October 2001 until October 2003. Benhamou served as chief executive officer of 3Com Corporation from September 1990 until December 31, 2000. Previously, he held a variety of senior management positions at 3Com.
In 1981, Mr. Benhamou co-founded Bridge Communications, an early networking pioneer, and was vice president of engineering until its merger with 3Com in 1987.
In 2003, Mr. Benhamou was appointed to the Joint High Level Advisory Panel of the U.S.- Israel Science and Technology Commission by U.S. Commerce Secretary Donald Evans. He currently serves as chairman of the board of Cypress Semiconductor and as a member of the board of RealNetworks, Inc and of Silicon Valley Bancshares. He serves on the board of directors of several privately held companies, and serves on the board of the New America Foundation, a Washington DC-based think tank. Mr. Benhamou serves on the executive committee of TechNet and of the Computer Science and Telecommunications Board (CSTB). He is the chairman of the Israel Venture Network, a venture philanthropy organization for a stronger Israeli society.
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