Bank’s Tech Bet Pays Few Dividends

In the dawning days of dot-com riches, the investment looked too good to pass up.

The federally funded Los Angeles Community Development Bank, burdened with debt and looking to generate revenue, would pump millions of dollars in venture capital into Internet start-ups.

The investments were never likely to meet the bank’s core mandate to create jobs in blighted neighborhoods, officials now acknowledge. But the chance to hit paydirt in the stock market--and free capital for the bank’s good works--seemed almost certain.

Fast forward a few years and almost the reverse is true. With the tech bubble burst, the bank has seen some of the start-ups nose dive and others dramatically downsize. Instead of basking in rich returns, it has tied up $35 million in hopes of a modest payoff down the road.

Making matters worse, the bank locked itself into the investments just as its loan portfolio began to nose dive. Interest payments to the federal government now exceed the money it takes in from borrowers by $300,000 a year, bank Chief Executive William Chu said.

For the city of Los Angeles, the bank’s viability is crucial--it backs the bank and stands to lose millions of dollars in future federal grants if it fails. Bad loans and litigation unrelated to the tech investments forced the bank to all but cease activities in the core neighborhoods it was designed to serve, and it is only now relaunching a modest loan program.

Yet, with $23 million already invested, the bank is committed to contributing $12 million more to the tech fund managed by Zone Ventures, the Southern California affiliate of Silicon Valley-based venture capital firm Draper Fisher Jurvetson. Moreover, nearly half the bank’s administrative budget--or $875,000--will flow this year to management fees for the firm, bank documents show.

“When we saw the high-tech companies in the Nasdaq start biting the dust, there was a lot of concern and discussion of ‘Why are we in this?”’ said Jasper Williams, a senior manager with the city’s Community Development Department, which oversees the bank. “But by that time, the contract had been executed and we were in.”

Supporters say the tech bet eventually could prove a success and earn the bank solid returns. But even if that happens, the investment has pushed the bank far afield from its mission. Of 570 jobs created by the Zone companies by last spring--the latest figures available--only six had gone to the low-income residents the bank was created to help, Chu said.

Furthermore, the downtown office towers where the companies are located fall outside the core neighborhoods of Central, South Central and East Los Angeles and Pacoima that the bank was chartered to revitalize.

And although the bank’s purpose is to serve needy businesses in poor pockets, the start-ups are headed and staffed by highly educated people who would have little trouble finding capital or jobs without taxpayer help, critics say.

Zone Ventures--which is bound by contract to help the bank meet its job-creation goals--does host networking parties open to the community, but charges up to $100 to attend. One featured Cindy Crawford, a spokeswoman for one of the companies funded with bank dollars.

“This deal was created to be an economic development boost for technology businesses in the inner city and to create jobs, whether that’s in Pacoima or South Central,” said Jon Goodman, executive director of USC’s high-tech incubator, EC2. “The fact that they [Zone Ventures] didn’t do it is all that matters. They had a contractual obligation with public funds [and that] is even more serious than a contractual obligation between two for-profit companies.”

Williams said the city is now monitoring the bank more closely.

And the Office of Inspector General of the Department of Housing and Urban Development--which committed an unprecedented $430 million of loans and grants to the bank in 1995--is wrapping up an audit of all bank programs, according to the independent watchdog agency. HUD also is reviewing the bank, a spokesman said.

Tim Draper, founder of Draper Fisher Jurvetson and Zone Ventures, said he laid out his plan clearly for bank board members, who approved each investment. The start-ups, he told them, would be headed by “world-class, brilliant potential heroes” and their management teams, with low-skill jobs coming up to eight years later.

The bank’s high-tech journey began in 1998 with a $25-million commitment--later increased to $35 million--to Zone Ventures. The bank contributes 99% to each investment. Zone Ventures commits 1% and makes all investment decisions.

Like all venture capitalists, Zone Ventures bankrolls start-ups, takes an ownership stake and helps manage the companies. If the companies become viable, the venture firm sells off the partnership’s stake--either privately or through a public stock offering--and everyone pockets a profit.

So far, Zone Ventures has used $23 million of bank money to nurture 13 high-tech startups. The companies--many of them dot-coms such as EStyle Inc., ShowBiz Data and AllPets.com--were once considered hot prospects for public stock offerings. But with Wall Street now largely shunning Internet plays, the chances of an early home run are unlikely.

At least four of the companies have ceased operations. One of them is TrafficStation, billed in May as “North America’s leading [online] provider of personalized traffic and traveler information.” The company received media accolades for its technology, but the bottom line never caught up.

According to court records, TrafficStation stopped paying some vendors last winter and by April--just one month after the bank approved an additional investment in the company--it ceased paying rent on its Wilshire Boulevard high-rise suites. Chu said the company still hopes to sell its technology, which could temper the bank’s loss.

Still, as a result of soured deals such as TrafficStation, bank officials have yet to get a penny back on their investment in Zone Ventures and now believe they won’t until at least 2003, said Chu, hired last year to help turn the bank around.

And although Zone Ventures recently has valued the bank’s investment in the partnership at $36 million, there have been no recent real-world assessments--such as acquisitions, public offerings or outside investments--to test the company valuations.

Bank and Zone Ventures executives stress that it is too early to judge the portfolio, as just one success eventually could earn the bank a strong return. The bank stands to get 80% of any profits from the investments.

“I’m still guardedly optimistic,” said Al Osborne Jr., who heads UCLA’s Price Center for Entrepreneurial Studies and served as a chief architect of the plan as head of the bank board’s investment committee.

“If we can get one winner out of this portfolio ... that would go a long way to get the principal back and then some,” he said. “Knowing what I know now, would I do it again? Absolutely.”

The bank was born after the 1992 riots, when federal officials crafted the Empowerment Zone program to help poor areas. Although Los Angeles served as a model for the program’s development, its application was denied as ill-prepared.

In its stead, the city got the bank--which operates under rules stipulating that each $35,000 lent or invested must create one job, and half the jobs must be for Empowerment Zone residents. Furthermore, 75% of the money was earmarked for the core Empowerment Zone, and the remainder for an adjoining Supplemental Zone (where the Zone Ventures companies are located).

The bank’s founding members believed that private dollars from big banks would supplement the HUD funding.

But by 1998, that money had not materialized. Osborne and the late C. Robert Kemp, then the bank’s chief executive, proposed setting aside “money that could earn extraordinary returns” and help the bank meet its core goals, Osborne said. That meant tech.

“The philosophy of the bank was, ‘We can ride the tide. We can go into this big thing where there’s a lot of money to be made and use that money to help out on the other stuff,”’ said board member Linda Griego, who served a stint as interim CEO in 1999.

To make its tech play, the bank turned to Tim Draper, the Silicon Valley financier who bankrolled last year’s unsuccessful Proposition 38, the school voucher initiative.

Draper’s company operates funds worldwide, focusing on high-risk early stage technology companies. He has invested in some of the Web’s big names, including NetZero and Hotmail.

The birth of Zone Ventures marked at least the third time Draper had launched a fund with taxpayer dollars--a rarity for venture capitalists.

“Private money usually wants to see a track record,” he said. “If you’re going to do early-stage seed investing in a new region--something I’ve decided is a worthwhile thing to do, it’s these [government contracts] that give you the kick-start.”

The deal, signed in summer 1998, was never supposed to be the bank’s entire venture capital program.

But as two other efforts that would have focused on blighted neighborhoods fizzled, Zone Ventures stood alone, said bank board Chairman Peter Taylor.

At the time, technology was looking more and more like a guaranty of riches, as dot-com start-ups went public and soared in value overnight.

In September 1999, at Osborne’s urging, the investment committee approved an additional $10 million investment for Zone Ventures, board minutes show. Zone was wading through 100 business plans a month, Draper told the committee, and needed more capital if the bank wanted to stay in the game. The full board approved the measure the next month.

With the beginning of the market decline in March 2000, dreams of a quick jackpot disappeared.

None of the companies has yet gone public and only one--Allpets.com--has been acquired, in exchange for shares currently valued at below the bank’s investment, said Chu.

Still, Zone Ventures partner David Cremin said that despite the failure of at least four of the 13 companies, some survivors are well-poised to outlive the downturn.

For example, EStyle Inc. now sells its maternity and baby clothes through Gap and Nordstrom. Cremin also touts as promising HiWire, an Internet advertising technology company; 3GA, a 3-D computer-assisted design outfit, and Zkey, a mobile personal technology provider.

Cremin said strong payoffs through acquisitions are likely in the next few years. But as the bank has scaled down its core activities, the technology commitments are pushing it out of compliance with HUD requirements.

A recent audit showed that only 53% of the bank’s federal loan funds and 34% of federal grants were spent in the core Empowerment Zone.

The companies have fared even worse when it comes to hiring. Each signed documents pledging to hire 51% of its employees from the Empowerment Zone, according to the partnership agreement between the bank and Zone Ventures.

Zone Ventures signed a separate agreement with the bank stating that it would “use all reasonable efforts” to achieve the goal.

Despite the fact that only six of the 570 jobs created by last March went to zone residents, no action has been taken against either the companies or Zone Ventures, bank and city officials say.

The bank has asked the companies to meet the requirement within two years of funding, but HUD places no such time limit on the hiring quota.

The poor recruiting record is not restricted to the technology companies. Only 19% of the jobs created by all the bank’s borrowers and investees have gone to Empowerment Zone residents, a recent audit shows. But, at about 1%, the tech companies performed far worse.

The bank has referred residents to Zone companies and proposed the creation of customized training programs.

But the bank’s compliance officer, Josie Starling, said none of the companies expressed willingness to participate in a hiring program, and some executives told her they have not even disclosed the public funding to their own employees.

Assistance from Zone Ventures has been weak, added Williams of the Community Development Department, whose office is channeling federal funds into a program to improve the bank’s overall hiring record.

“They had an obligation to work with the bank in helping the bank meet its obligations to the city,” he said. “I don’t think that was done effectively nor do I think there was a sufficient effort deployed, obviously.”

The city serves as the lender to the bank, dispensing the federal funds upon request. It guarantees those loans with anticipated federal community development block grants--so if the bank were to default on its debt, future city projects would suffer, city officials say.

HUD said in a statement that it determined last fall that “the bank was not in compliance with HUD’s job creation requirements.”

The agency said it is reviewing the bank’s investments to ensure they “create jobs and businesses that serve Empowerment Zone residents.”

When asked about outreach efforts, Cremin said networking events sponsored by the nonprofit Zone Club, such as the one model Crawford attended, were held in the Empowerment Zone “so residents could learn about what we were doing.”

Cremin added that Zone Club volunteers have reached out to the community in other ways, teaching schoolchildren about business and offering “mommy and me” yoga classes at a Pico-Union nonprofit.

“On all fronts we’ve made great strides to achieve the goals of the bank,” he said. “We haven’t achieved them all, but we’re a very young company.”

Still, critics point out that Zone Ventures has fared better than the low-income residents and neighborhoods it aims to serve.

The bank deal subsidized Draper’s entry into the Southern California market, and Zone partners used bank dollars to finance two companies of their own making.

Draper said board members approved those deals. Still, critics say independent and potentially promising entrepreneurs committed to local hiring couldn’t get near Zone Ventures’ door.

Goodman, of EC2, said she referred three companies to Zone Ventures. Two never received return phone calls, she said, and representatives from a third got an appointment but were stood up and never recontacted, Goodman said.

City and bank officials also are concerned that the bank has not been kept abreast of company problems. According to the partnership agreement, Zone Ventures must notify the bank in writing within 10 days of learning of any company’s breach of federal requirements, which include location.

Yet in the case of TrafficStation, bank officials learned from a reporter that TrafficStation was no longer operating on Bunker Hill.

Concerned about oversight, the city last March directed the bank to conduct its own “periodic financial analyses [including reviewing financial statements] of Zone Venture companies.”

Last month, Chu visited Zone Ventures for the first time to review its books. Yet even after doing so, he said, he had no idea that TrafficStation had laid off its staff and abandoned its offices.

Cremin said he told Chu that TrafficStation was struggling but didn’t say more because he thought conditions might improve.

Disturbed by the lack of disclosure, Chu met last month with Zone Ventures partners to ensure that crucial information is relayed in a timely manner.

“We need to make judgment calls on financing issues, both for the venture fund and as it relates to the overall health of the bank,” Taylor said. “I’m not averse to bad news. I just want it to be timely and accurate. That’s the only way we can make good decisions to protect the bank, the city and [federal] monies.”

Chu is preparing an analysis for the city on which companies are most likely to make it and should get the $13 million the bank already has pledged to the partnership.

He also plans to direct the $4 million in new loans authorized by the city last March into the core Empowerment Zone, in hopes of bringing the bank closer to compliance with federal goals.

“That’s all I can do,” Chu said. “I can’t correct the past.”

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Times researcher Penny Love contributed to this report.