High-Tech Investors Grow More Wary, Slow Capital Flow

The last thing Jim Goodwin wanted to do when he started trying to raise money for his electronics subcontracting business last October was to sell out to another company.

Goodwin, the president of Chatsworth-based A. J. Electronics Inc., explained that he and his two partners “worked 18-hour days, seven days a week for a lot of years” to build up the company.

“We were going to trade that for what, to be employees?”

By March, however, Goodwin consented to the sort of deal he once thought he would never accept: A. J. Electronics was acquired by Data-Design Laboratories, a much larger company listed on the New York York Stock Exchange.

Money for Expansion

Goodwin considers himself lucky nevertheless. Although he didn’t secure the kind of financing he initially wanted, he still got the money needed for the continued expansion of A. J. Electronics, which assembles components for products such as burglar alarms.

Many of his high-tech counterparts haven’t been so fortunate over the last two years. They have found that financiers have grown increasingly skittish about investing in any but the safest bets in the technology industries.

Even the hot properties are at the mercy of investors who are driving harder bargains. The also-ran technology companies, meanwhile, are being sent away empty-handed.

That trend, which experts say shows no sign of reversing, poses a special threat to the San Fernando Valley, which is studded with high-tech companies. If the entrepreneurs who are trying to form companies or to expand young companies cannot find financing, their businesses often wither or die, casting a pall over the entire local economy.

“In times like this, only the best-managed companies survive,” said David Hornbeck, the director of business research at California State University, Northridge.

Statistical Gauge

Few statistical gauges of the health of the Valley’s economy exist. But Hornbeck said the number of businesses in the area with 20 or more employees has declined over the last two years, apparently partly because of the financial markets’ edginess about technology companies.

The number of businesses of that size fell from 9,128 at the end of 1982 to about 8,900 at the end of 1984.

(At the same time, the number of firms with fewer than 20 employees increased from 3,600 at the end of 1982 to 4,100 at the end of last year. Hornbeck said the gain reflected the opening of new shops and other retail outlets that serve the area’s growing population.)

The landscape of financiers who put their own money or channel clients’ money into technology companies commonly includes commercial bankers, wealthy individual investors and brokerage firms. But the highest-profile figures in the market are the so-called venture capitalists, investment experts who direct their clients’ money into fledgling, but apparently promising, businesses in exchange for a share of the ownership.

When the stock market started placing high values on technology companies in the early 1980s, financial institutions and individual investors began pouring their money into venture capital firms. They counted on the venture capitalists to spot attractive private companies that eventually could be taken public at hefty profits.

‘Mad Frenzy’

“What I saw in the Valley,” Goodwin said, “was a mad frenzy to throw money into buckets.”

The flood of money gave rise to the development of scores of new companies.

“A year, two years ago, this looked like high-tech heaven,” said Larry Scherzer, managing partner of the Woodland Hills office of Arthur Young & Co., a Big Eight accounting firm.

The boom in investment, however, also fostered a competitive blood bath that continues to plague computer companies and other high-tech businesses. Two of the largest technology companies in the Valley, Tandon and Dataproducts, announced major layoffs last week that stemmed from the intense competition.

As a result, investors have lost some of their ardor for technology companies. Venture Economics Inc., a Massachusetts research firm, estimates that the funds investors put into venture capital firms nationally dropped from $4.5 billion in 1983 to about $4 billion in 1984 after growing rapidly in previous years.

Direct Investors Pull Out

The decline in investments earmarked for young technology companies probably was even greater. Experts say that many pension funds and insurance companies that invested directly in the companies, without using venture capital firms as intermediaries, have pulled out of the market.

Although the amount of venture capital available still is substantial--the money committed to venture capital firms last year was the second-highest sum ever --investment experts say there also are an unprecedented number of entrepreneurs vying for the money.

The result is “a heavy dose of reality” for would-be technology barons, said Rock Hankin, managing partner of the Woodland Hills office of the Price Waterhouse accounting firm.

Venture Economics estimates that the money flowing from venture capital firms into their investments rose modestly last year, from $2.8 billion in 1983 to $3 billion in 1984. But the firm said that an increasing share of that money apparently was used to nurse crippled technology companies rather than to help new companies form or to help promising companies blossom.

For the Jim Goodwins of the world, that financial market means money for expansion is harder to come by.

Low Value on Company

Goodwin said that at first he would have preferred to obtain financing for A. J. Electronics from a venture capital company or a stock offering arranged by a brokerage. But he said that venture capitalists and brokers placed unexpectedly low values on his company.

One offer from a venture capital firm was to inject $1 million into A. J. Electronics in exchange for a 30% stake in the company. Goodwin, however, only wanted to give up 15% of the company for that amount of money. Besides, he feared that venture capitalists would exert too strong a grip on his company after the deal.

“Once it’s done, they’re going to move in their desks and watch their money,” he said.

Goodwin said he was happy with the deal A. J. Electronics, which assembles and tests electronic components for manufacturers of equipment such as computers, appliances and burglar alarms, reached reached with Data-Design.

The transaction left him largely in charge of the company he helped found, which has 250 employees, and still provided him with a share of its profits.

‘A Good Marriage’

“I think we’ve got a good marriage,” Goodwin said.

Daniel R. Carter, president of Corona Data Systems of Thousand Oaks, probably would envy the deal that Goodwin got. Even though his computer company has been profitable, at least over the last 18 months, it has looked, unsuccessfully, for extra financing since last October.

In 1983, Carter said, the financial scene “was all roses and peaches and cream. Now everybody’s scared to death.”

Carter’s need for capital intensified in January when one of Corona’s principal lenders, San Jose-based Bank of the West, decided to recall its $5.4-million loan to the company. Carter and G. Bradford Jones, a Los Angeles venture capitalist with an investment in Corona, speculate that the bank recalled the loan simply because it wanted to reduce its portfolio of loans to high-technology companies.

Carter and Jones say many other financiers have avoided putting money in the company because they are wary of nearly all personal-computer manufacturers.

‘Could Be Ravaged by IBM’

“The problem is that people are worried we could be rapidly ravaged by IBM,” Carter said.

He laments that many financiers never take time to consider that not only is his company profitable, but it makes printers and a computer network in addition to personal computers that are compatible with the IBM PC. Carter said Corona, which employs 225 workers, chalked up $63.4 million in revenues last year.

There are happier stories among the Valley’s high-tech entrepreneurs.

Take Alfred Joseph, for example. It took Joseph, founder of Vitesse Electronics of Camarillo, all of six weeks to attract an investment of $30 million for his company from the Massachusetts-based Norton Co. Vitesse, which has 60 employees, is developing and eventually plans to manufacture high-speed computers and integrated circuits.

“If you have good ideas, and if you are properly staffed, have properly planned and if you go to the right investors, you won’t have a problem,” Joseph said.

“All I had was a damn good business plan and I was able to raise that money.”

But even Joseph has harsh words about venture capitalists. He said some of them “couldn’t tell the difference between an A-plus team and a B-minus team.” Joseph also said that many are poor business partners because they are looking only to make quick profits.

Furthermore, Joseph and other high-tech executives accuse venture capitalists of following the crowd, of refusing to independently judge a company if another venture capitalist has turned it down.

‘Sheep-Herd Mentality’

“I’ve got to be sure the first one I meet will kiss me on the lips,” Joseph said.

Chris Lewis, a partner in Riordan Venture Management, a Los Angeles-based venture capital firm, generally agreed with that assessment.

“In the venture capital community, even though it wants to be independent, there is a sheep-herd mentality,” Lewis said. “If one company wants to do a deal, they all want to do it.”

Many experts expect money to resume flowing into high technology once the industry pulls out of its current doldrums. A hopeful sign was the apparent trend over the last year of major corporations such as General Motors and Ford to make major investments in technology companies.

Among the recent beneficiaries of that trend is Simi Valley-based View Engineering, which swapped 20% of its ownership for an investment from GM.

“With the whole venture capital market drying up here, or at least going down to a trickle, and with lots of ideas here, people are looking for alternate sources of financing,” said Scherzer, the local Arthur Young partner.

Harder Line

For now, however, financiers are taking a harder line with companies that knock on their doors asking for money. Venture capitalists are paying an estimated 30% to 50% less than they did two years for stakes in technology companies, and they make sure to have escape hatches that will allow them to sell out if the going gets rough.

All that is producing tension between the financiers and the high-tech entrepreneurs, who feel unjustifiably spurned.

The anger is unmistakable in the voice of Melvin Fuller, a partner in Inventors Licensing & Marketing Agency, a Tarzana-based firm that helps inventors establish businesses to manufacture and sell their products. Fuller said the term venture capitalist “is a misnomer.”

“They’re sophisticated, ersatz bankers. They don’t risk a damn thing.”

But, Fuller added, “He who’s got the gold makes the rules. It’s too bad, but it’s true.”