There are apparently two major forces behind the trend. For one thing, many young companies have been forced to seek sources of capital outside the venture community, which has grown cool to start-ups in recent years. That's because venture capitalists have been finding it more difficult to make money on early-stage financing. "As returns go down, people look for other investments," observes Fred Warren, a partner at Brentwood Associates, a Los Angeles venture capital firm. "It's a natural shift." Between 1986 and 1987, for example, the amount of venture dollars invested in start-ups declined from 16% to 11%. Today some of the industry's leading firms, such as Brentwood, place the bulk of their investments in latter-stage financings and leveraged buyouts. In 1983 the $161-million Brentwood IV fund allocated only 25% of its money to leveraged buyouts, using the rest as traditional venture capital. More than 70% of the firm's current $210 million has been placed in LBOs.
This shift in priorities has affected everyone looking for venture backing, even such well-known company builders as Conner. And it has been devastating to relatively obscure entrepreneurs in capital-intensive businesses built around technologies with which investors are unfamiliar. Moshe Alamaro, for one, spent the better part of two years trying to raise venture capital for Deshen International Inc., a Boston-area company formed to develop and manufacture movable electric-arc fertilizer plants. Using a long-neglected process discovered by Christian Birkeland and Samuel Eyde in 1903, the technology would allow the same equipment to manufacture fertilizer in, say, Canada during the summer and the midwestern United States during the winter -- thereby taking advantage of electricity available at off-peak rates. Alamaro is now seeking his funding from companies he sees as the natural beneficiaries of his venture's success: the utilities that would be able to sell their excess capacity, the engineering firms that might build his systems, and so forth. "I don't think venture capital firms are very venturesome anymore," he says. "They've gotten to be like banks."
But changing fashions in venture capital are not the only forces driving the trend toward natural partnerships, nor even the most important. Perhaps the greatest impetus has come from new attitudes in corporate America -- notably, the discrediting of the once-prevalent notion that big companies produce virtually all the major technological breakthroughs. These days, Fortune 500 companies regularly seek the assistance of smaller businesses in developing new technologies and products. Even the proudest of the giants, IBM, has invested in such small companies as Wisconsin-based Supercomputer Systems. Other big companies known for start-up investing include 3M, Corning Glass, Analog Devices, and Digital Equipment.
"The not-invented-here syndrome is not that common anymore," says Arthur L. Rosenthal, vice-president of research and development for Davol Inc., a subsidiary of C. R. Bard Inc., a Fortune 500 company with several small-company alliances. "Fifteen years ago you didn't see so many of these small, technically advanced firms. Now, they're of major importance."
At the same time, big companies have grown more sophisticated and focused in their investing. Through a pro-cess of trial and error, a growing number have learned that the best policy is to invest in start-ups whose technology or service fits into the larger company's core business.
Consider San Francisco-based McKesson Corp., the nation's largest distributor of such nondurable goods as pharmaceuticals and general merchandise. David Malmberg, the company's director of strategic planning and new technology, readily admits that McKesson took several disastrous turns with start-ups in fields outside its area of expertise. "We were making investments all over -- we'd look at anything," he says. "Nuclear technologies, software companies. It was ridiculous. We had no business in these areas. But it was the popular thing to do, and we were riding the crest of the wave. Then, all too often [the companies] just went south."
Chastened by the experience, McKesson now puts all investment decisions through a screen designed to filter out deals unrelated to its core distribution business. One company that passed the test is a Hayward, Calif., software house developing a computerized warehousing system -- a product with obvious benefits for the $7-billion distributor. McKesson also decided to invest in Slzrco (pronounced seltzer-co) Partners, a seltzer company in Monrovia, Calif. That deal, however, took an unexpected turn.
In the early 1980s Rich Hagan, a disabled Vietnam veteran, founded Golden Gate Bottling Co. His idea was to sell old-fashioned seltzer in glass bottles with siphons attached. Hagan bought tooling from an old siphon manufacturer in the Bronx, N.Y., collected glass seltzer bottles from around the country, and went into business. Before long, he realized that he would have to come up with new forms of packaging if the business was to expand. So Hagan teamed up with several investors to launch Slzrco Partners and went to work developing a plastic siphon for use with plastic bottles.
Although Hagan solved the technical problems, he quickly ran into financial ones and began approaching venture capitalists. "They liked the idea and were intrigued by the product," Hagan recalls. "But [at the time] they invested in high tech. I guess this didn't qualify."
