Silicon Alley 2.0Crash Reboot Relaunch

As founder of flatiron partners, Fred Wilson runs almost half a billion dollars of the smartest money in town. A great deal of it is parked in technology start-ups – New York ones. But up in a conference room that overlooks Gramercy Park toward the East River, Wilson is admitting that, despite a peerless network of contacts and fourteen years of venture experience, he’s perplexed by what’s happening in Silicon Alley. The pendulum has swung too far. * “We’ve gone from a period where there was stuff I didn’t understand on the overinflated hype side to where we’re seeing stuff I don’t understand on the negativity side,” says Wilson, settled into one of the ten or so gray rolling chairs that fill the cubicle-size room. Sure, nasdaq is crashing, the IPO market is DOA, and dot-coms are shutting down and scaling back daily. But “when people start throwing in the towel on good businesses that make sense” – off the top of his head, he mentions vitamin e-tailer (“a replenishment business; should be great for the Web”) and electronic-invitation site eVite (with tons of traffic, wouldn’t a portal buy it eventually?) – “I take that as the sign of a bottom.”

When smart money senses a bottom, it starts buying, and, at Flatiron, the shopping has already begun. “I now feel tangibly for the first time in six months that everyone here is saying, ‘We’ve got our house in order; let’s go out and find some deals to do,’ ” says Wilson. “And if we’re starting to do it, other people are starting to do it, too.”

Fast, fat, and heavily hyped, New York’s late-nineties tech boom was in many ways a flash in the pan. But as with any gold rush, it made a lasting mark on the surroundings. Venture capitalists, programmers, and digital-media firms – the Internet equivalent of banks, miners, and general stores – have staked out their territory and are here to stay. “Whatever ups and downs we’ve gone through – and millions were created and wiped out – one thing all that did,” Wilson professes, “was to create a base of entrepreneurs and people who understood how to work in and finance small companies. That’s been woven into the New York economy forever.”

Despite its sharp downturn, Silicon Alley has joined Wall Street and both Seventh and Madison Avenues as a convenient, if inaccurate, geographic shorthand for one of the Big Apple’s core businesses. When the history writers tackle turn-of-the-century New York, the extravagant catered launch parties and in-house masseurs will be mere footnotes in a chapter about the city’s emergence as a world-class high-tech center.

Like every other fixture of the city’s economy, Silicon Alley will cycle between boom and bust. “There’s a lot of VC money sitting on the sidelines right now, because no one wants to be too early,” Wilson admits. The question is what it will take to get that money off the bench and into the game.

“People in New York are smarter than they are in California,” says the recently transplanted CTO of a local start-up. “Silicon Valley is just dense with geeks.”

“After the New Year, with a new president and the 2000 crash consigned to the past, there’ll be a lot of money flowing again,” says David Bennahum, a former tech journalist turned partner at New Things Ventures, a fund that invests exclusively in wireless companies.

Some think the tech sector has already begun to bounce – “the bottom was about three weeks ago,” dot-com buyout specialist Scott Hyten told Web M&A Update, an industry newsletter, in mid-December. Others believe a turnaround will take longer, and that the Alley will continue to suffer in the interim. Either way, venture-capital funds will need to start putting their money to work. Investors put so much money into tech-venture funds over the past couple of years that when VCs cut back the flow in the spring, their cash built up like water behind a dam. Now there’s pressure on them to release it downstream to start-ups; since their profit comes mainly from their investments’ return, they can’t earn much, or grow, unless they spend what they have and raise even more.

When the VCs reopen the floodgates, they could actually shower as much, or more, seed capital on the local economy as they did during the boom. According to Robyn Beresh, a researcher at Asset Alternatives, a VC-industry research firm, New York City-based venture firms raised more than $43 billion in 2000 – 30 percent more than in 1999. “Historically, VCs tend to invest close to home,” notes DoubleClick CEO Kevin Ryan, for the simple logistical reason that it’s easier to keep tabs on what your money’s doing if you’ve parked it across town instead of across the country. While Flatiron and newer New York firms like RRE Ventures do fund California deals, they prefer to keep as much of their portfolios as possible a cab ride away.

The local venture scene has also begun to get its act together, literally. In the Valley and around Boston, top firms such as Benchmark and Kleiner Perkins routinely cut deals in syndicates. One lead firm does most of the homework, sets the pricing terms, takes a board seat, and brings other VCs in as financial partners. This spreads out risk and builds relationships among firms, and gives them bargaining leverage as well. But New York venture money, with its roots in rivalrous Wall Street, is only beginning to work that way. “We started out as competitors,” Wilson observes. “Now we’re realizing we should be collaborators.”

“Because of Wall Street and the law firms, there was a tendency to overlegalize things,” recalls John Borthwick, who sold Total New York to AOL in 1997. “People used to say to me, ‘Out West you can get a deal done, and back here you have to go through 50 lawyers.’ ” Now head of AOL’s 18th Street-based new-product-development team, whose activities include acquisition-hunting, Borthwick believes the past two years’ trial by fire has brought the city a class of financiers and executives experienced in the Internet’s speed and collaborationist style. The upshot: As local VCs begin to gang up and bargain collectively with promising start-ups, it will be harder for the city’s entrepreneurs to exact massive 1999-type valuations. But it should also enable more deals to close.

Besides a few personal fortunes, and a lot of promotional T-shirts and mouse pads, the most important legacy of the Silicon Alley bubble will be an infrastructure – of bandwidth and hardware, but more important, of people. No, New York isn’t going to trump the West Coast’s overall technology dominance – there’s way too much space, talent, experience, and academic firepower in the Valley for New York to mount a serious challenge in more than a few sectors. Yet technology remains a major engine of growth here – the biggest new segment of the local economy in decades. “Silicon Alley isn’t just some content and e-commerce guys now,” insists New York City Investment Fund president Kathryn Wylde. “In only four years, it’s become a very rich environment.”

While many of the species that inhabited that environment are proving unable to survive outside the hothouse, others seem to be thriving. In addition to the city’s more than two dozen tech-oriented venture-capital funds, incubators, accelerators, expediters, and hurry-it-uppers geared toward newborn companies, New York now has lawyers wise in the ways of speed-drafting equity agreements, overnight marketing partnerships, and acquisition documents – and willing, perhaps, to accept shares in lieu of cash. Serious software engineers, who used to barely journey beyond the confines of Wall Street, left their investment banks to get a piece of the dot-com boom; others emigrated from the West Coast and stayed because they (like so many before them) found the city to be a productive place to do business and an exciting place to live. “People in New York are smarter than they are in California,” says the recently transplanted CTO of a local start-up. “I’m very happy to be here. Silicon Valley is just dense with geeks.”

For hard evidence of the Alley’s hidden vitality, check out the Real Estate section of the Sunday Times. According to Kenneth Salzman, director of Newmark Realty’s IT practice, “Midtown South is currently the tightest market in the city,” with Flatiron-district space averaging more than $40 a square foot, up from $30 just a year ago. Salzman (himself a Net mogul, having founded and sold Globix, a publicly traded ISP) sees that rise continuing, if at a less-heady pace, because he expects demand from start-ups will continue unabated.

“For access to capital and labor, small-space users need to stay in New York City,” says Salzman. “That’s why there’s been almost immediate absorption of available space,” even in far-west and northwest Chelsea. And while dying dot-coms occasionally furnish the market with less-expensive sublets, just as typical is what happened with the office space at 195 Broadway that leased and then reneged on before even moving in: Morgan Stanley sucked it up instantaneously, and at a higher rate.

When the monetary pipes do unclog, where will the liquidity flow? Ask a sampling of Alley savants, and a few ideas keep coming up.

The No. 1 answer by far these days is wireless and mobile – a broad area covering anything to do with cell phones, Palm-type devices, and portable Net access. New York has two important advantages that could let it surpass Northern California as the hub of this emerging industry.

“Culturally, we’re meeting our Old Economy clients in the middle. I used go to meetings and I’d be the wacky Web guy. Now they’ve dressed down to our level.”

The first is the region’s historic strength in telecom science, the technical underpinning of phone-related companies. “New York City is within 50 miles of AT&T, Lucent, Bell Labs; NEC’s lab is in New Jersey; IBM is in Yorktown Heights,” Bennahum points out. “The Eastern Seaboard right around here has more of that stuff than Silicon Valley.” The second is Wall Street, the mother lode of early wireless adopters. “The first people to buy this stuff are financial-services guys,” says Josh Newman, editor of Unstrung, the New York-based wireless-industry Webzine. “Joe Investment Banker is standing on the sidelines of his kid’s soccer game using some cool app, and then his neighbor sees it and that’s how it spreads.” Unstrung (which is owned by SkyScout, itself a wireless-data-services hopeful) launched in March and is quickly becoming the wireless biz’s answer to the Silicon Alley Reporter. “Because you’re constantly dealing with giant corporations in this field, though, there’s a lot less personality-driven stuff in Unstrung than in SAR,” claims Newman, with none of SAR founder Jason Calacanis’s self-promotional flair.

So far, the biggest hit in Unstrung’s sector is Vindigo, the company whose city-guide software loads onto Palm Handhelds and, soon, phones and other pocket-sized devices. With 260,000 users in its first nine months and the Palm population set to double again to 20 million users next year, Vindigo plans to license its platform for organizing information by the user’s location to content providers worldwide. Helping Vindigo develop its technology for the phone market is West 35th Street’s Vettro, which raised $12 million this fall – a very healthy first round in so tight a market. Eventually, Vettro CEO Rodger Desai wants to be the IBM of wireless – selling expert consulting services (many Vettro staff members have worked in the more advanced European and Japanese wireless industries) along with house-blend software and other technology products.

Another wireless start-up, Outercurve, still shacked up in its West Village incubator’s offices, is playing exclusively to the financial set. It delivers wireless stock quotes, charts, options chains, and other financial news to a Blackberry (the current must-have wireless handheld gadget) for about $100 a month. To court a more general-interest audience, Upoc is getting a lot of attention for its group-messaging application, which it’s promoting as a way to report celebrity sightings to all your friends at once.

Perhaps more surprising than the buzzing wireless scene – which at least resembles the media and content companies that made up the Alley’s first generation – is the city’s increasing number of pure infotech firms. Take, for example, DataSynapse, a red-hot prospect in the utterly geeky field of distributed computing. DataSynapse has created a secure way for processor-hungry companies (for example, multinational banks that need to crunch numbers overnight) to broker computing power from anyone with an idle broadband Net connection. CEO Peter Lee is initially targeting the world’s top 500 financial institutions, which he says spend an average of $25 million a year each just on risk-management technology – a sliver of the Street’s overall tech spending. Because of his banker client base, Lee decided to plant his firm in Manhattan. “Three or four years ago, you’d have been hard-pressed to find a core-technology company in New York,” says Lee. “But we have had no problems getting deep-technology people. We see a lot of transplants from the West Coast, and we’re picking up people here from other Web projects, like a guy who ran broadband development for a major publisher, and a systems architect who didn’t want to be in the content business.” Lee expects to close a $25 million second financing round in January, and says DataSynapse could be in the black as early as next year’s fourth quarter.

Business-software firms have also been getting a lot of investor attention. Most target industries are already rooted in the city – think publishing, marketing, and finance. Compared with the media-content plays people had come to associate with the Alley, says Stuart Ellman, a general partner of RRE Ventures, “these sound much more boring.” But if there’s a lesson to be drawn from the Alley’s adolescence, it’s that excitement does not necessarily make for a great investment.

Ellman’s enthusiasms lie in mundane application providers: “If you look carefully at the past year or so, there’s been an explosion in business-infrastructure companies” right here in New York, where Fortune 500 headquarters are thick on the ground. “Sell the solutions for half a million to a million dollars, the client reaps $5 to $10 million in savings – these are classic software businesses,” he boasts. So RRE’s been throwing chunks of its $350 million fund into start-ups as fast as ever in recent months. “It’s a huge buying opportunity,” says partner Jim Robinson IV. “We’re aggressively doing deals.”

Local RRE favorites include Capital Thinking, whose software automates the commercial-mortgage process (launched in April; four major clients, including J.P. Morgan, are already signed), and Notara, which makes applications that simplify brand management and licensing for customers like Tommy Hilfiger and the NFL.

Another business-infrastructure play, aimed straight at the publishing industry, should be dear to the hearts of managing editors everywhere: Outerforce’s software manages assignments, contracts, and payments for freelance writers, photographers, designers, and researchers. Company founder (and former New York Times Digital exec) Jonathan Glick calls it “supply-chain management for content.” Having raised enough money ($8.3 million in October) to get through 2001 comfortably, Outerforce has potential investors ready to pony up more.

Nor has the Alley’s downturn wiped out commerce sites, content plays, or the true-believer entrepreneurs who dream them up – the kind of people who would be starting companies on day two of a nuclear war. “Everyone told me it’s the worst market in a long time even though VCs are sitting on a lot of money,” shrugs David Sidman, who quit his job at John Wylie, the scientific-publishing house, to found Content Directions, which will develop digital-rights management systems. With the sort of enthusiasm that was supposed to have gone out of style in April, he gushes that “this was kind of a once-a-century situation – it didn’t feel risky to me.” So far he’s self-funding, but he’s circulating his business plan far and wide. It’s enough to give a Class of ‘95er a fit of nostalgia.

Those old-timers still have plenty of occasion to reflect wistfully on their bygone corporate youth: Plenty more layoffs await companies that grew too fast or never had a real path to profitability.

Yet the long-term picture looks bright. For the Alley’s core constituency of design-and-build Web shops (Razorfish,, and Organic on the high end, and countless boutique firms beneath them), the yeoman’s labor of Web-ifying every business under the sun remains. Many shops are humming along with higher head counts than they had twelve months ago. “Any real business that has anything to sell or do still needs Internet-integration services,” says Danny Scheman, a co-founder of Media Farm, a 25-person firm situated, in its West 20th Street loft, in the heart of the traditional Alley. “There’s so much work.”

Rae Rosen, a senior economist at the Federal Reserve Bank of New York, concurs, projecting that local demand for high-tech workers will continue to grow quickly “for at least the coming year.” “The question is whether we can meet the demand,” she cautions. “We’re seeing a lot of people moving back to New York from within the U.S., particularly young people. Plus, international immigrants tend to be attracted here.” Many Indian-born programmers, for example, elect to bring their skills to New York in part because of the enormous South Asian communities in Queens and New Jersey. More H1-B visas (which Congress recently approved) means more immigrants, which could well mean more coding muscle for the tristate area. The city is growing its own, too: According to Kathryn Wylde, cuny is offering more classes and granting more degrees in technical fields than ever before.

As New York’s tech industry becomes less of a land grab and more of an actual profession, one type of employee who may have trouble finding work is the one who occupied the Alley’s cubicles to begin with: the basically smart but unspecialized liberal-arts grad. “Being an Internet generalist can’t fly anymore,” says veteran Net strategist Carolina Reid. “It’s more like ‘This guy knows the plastics-manufacturing industry inside out’ – you need to become more expert in one area now. It’s going to be a grayer, older crowd.”

That sober observation may be the ultimate catch for the majority of Alleyites who never made (or lost) millions. There are still plenty of jobs, ideas, and dollars around. What’s gone for good is the unchecked youthful utopianism – the visions of dyeing your hair, playing with expensive gigatoys all day, and getting paid more than your lawyer cousin to do it.

The mystique is gone, too. In addition to introducing a new generation to the wonders of capital formation, the Net-stock runup focused ostrich-headed corporate America on all things digital. In a business fueled partly on Us-versus-Them, there is no Them anymore. These days, pretty much everyone Gets It.

In other words: The nineties Alley was right about the digital revolution, so the rest of the city assimilated. “Culturally, we’re meeting our Old Economy clients in the middle,” posits a production executive at a top publicly traded Web shop. “I used go into meetings and I’d be the wacky Web guy, with everyone else in suits. And now they’ve dressed down to our level. It’s a little less fun for us, but everyone else has loosened up.”

“There’s still a lot of business,” laments Reid. “There’s just not a party anymore.”

Silicon Alley 2.0Crash Reboot Relaunch