Kevin Fong

The Specialist

When a leviathan venture firm like Mayfield — which has $2.5 billion under management and is working on its eleventh fund — and a veteran VC like Managing Partner Kevin Fong — whose “home runs” include RedBack Networks, TIBCO Software, BroadVision and webMethods — start slowing down their rate of investment, you know that the market for start-ups has changed dramatically.

“The biggest story for the year is the capital markets have a huge effect on communications,” Fong says. “You cannot grow a service provider without two major elements: low cost of capital — debt or equity — and consumers to buy the services. Capital markets are in disarray and customers are being very cautious in their spending.”

Mayfield is also cutting back. The firm will invest in about 20 companies this year, Fong says, or about $100 million to $150 million. “It's way off the pace of last year,” he says. “We are definitely seeing a slowdown of new ideas.”

Large, capital intensive projects are not being funded as VCs develop a more conservative risk profile, Fong says. “VCs have never funded businesses completely independently. We're dependent on the funding chain, including the public markets. What everyone else looks at makes a difference to us.”

Equipment companies launching next-generation gear this year and next will be in the most trouble, predicts Fong, due to sustained lower capital spending. But because VCs invest in companies today that won't ship product for two to three years, they will probably catch the upturn.

For example, the optical area still poses a very interesting ROI opportunity, but it is also marked as being very “copycat” right now, Fong says. “One, two or three will be successful, not 10, 20 or 50. In the past almost anything in optical did very well.”

Mayfield has stakes in White Rock Networks, a metro optical Sonet equipment provider, and more recently invested in IOA, an optical components company that is still in deep stealth mode.

The mobile Internet is another greenfield area, Fong says, estimating Mayfield has $70 million tied up in early stage wireless companies. “The availability of the Internet everywhere is going to be slowed,” he says. “We're still interested in things like telematics but they will take longer to come to fruition.”

Fong is an investor in Mobilstar, a wireless ISP providing 802.11b connections in airports and coffee shops. But for now it is infrastructure plays and solutions for managing infrastructure that will see market demand, he says. For example, Wireless Online, another Fong investment, is building smart antenna systems for operators that want to improve network capacity to accommodate wireless data.

While Fong doesn't rule out investing in new service providers, he admits it would have to be “a very special situation.” Fong and Mayfield were burned by at least one service provider play this year when Geocast Network Systems, developer of a multicast transmission scheme to deliver audio, visual and interactive content to PCs, closed shop.

“It was a data broadcasting service that was 15 months from deployment,” Fong says. “They needed an additional $20 million to $40 million to go after a consumer play.” He won't say how much the fund had invested in Geocast.

Like most VCs, Fong and his partners spend more time with existing portfolio companies these days, but they are also culling their portfolio of the weakest links.

“Faced with today's environment, we are looking much more carefully at which companies have a future and which don't,” Fong says. “There will definitely be some companies that will not be supported by us.”

How long the economic distress will last is anybody's guess, but Fong says he is counseling his companies that it could be around 12 months. “The best advice we are giving our companies is to batten down the hatches.”