Mining A High-Tech Legend Investors Bet On Packet Engines Based On Founder’s Track Record

Want to see a venture capitalist salivate?

Say two words: Grand Junction.

Grand Junction Networks was a little company founded to work high-tech wonders, which it did.

The technology it produced was revolutionary.

But the profits it manufactured in the process have become legend.

Venture capital investors put $4 million into Grand Junction as a raw concept. Two years later, Grand Junction was sold for $350 million.

“I have heard,” says veteran securities lawyer Barbara Fiske, “that it was the highest return of any venture capital deal in the Silicon Valley up to that time.”

Now, even though the Grand Junction magic was performed long ago (between 1992 and 1994, which in high-technology years adds up to eons) and in a galaxy far, far away (you can’t get much further removed from the high-tech, high-finance culture of the Silicon Valley than Eastern Washington), the Grand Junction legacy may have a profound effect on the topography of Spokane’s economic landscape.

“Lets face it,” says Peter A. Price, former North American controller for Microsoft, and current chief financial officer of Packet Engines, “the Grand Junction story is why we’re all here today.”

The Grand Junction story is also why some of the most sophisticated investors in the country have lined up with $23 million to buy a piece of Packet Engines, a small, year-old Spokane company that has yet to put its first products into production.

The thread linking to Grand Junction is Packet Engines’ founder and president Bernard Daines.

“Bernard’s reputation is the key,” says Fiske, former senior attorney for Intel Corp., and current vice president of business and legal affairs at Packet Engines.

“The (venture capital) industry knows that Bernard was the chief technical officer who created the technology that made Grand Junction so valuable.”

Daines’ vision calls for Packet Engines to exceed Grand Junction’s technological accomplishment tenfold. Living up to Grand Junction’s financial legacy may be way too much to expect. But the level of financial sophistication Daines is building into his new company isn’t taking a back seat to the technology.

“The way this company has been organized and financed, and the way people have been recruited to it, is really unlike anything I’ve ever seen done in Spokane,” says Thomas C. Simpson, managing director of Spokane Capital Management.

“It fits Silicon Valley standards to a T.”

Investors seek quick return

The financial and ownership structures of these new age companies are designed to change as quickly and nimbly as the technology that drives them.

People in Spokane are used to seeing companies grow old and become economic icons, sometimes run by second and third generations of the founding families.

Existing high-tech stalwarts - companies like Key Tronic, or Gary Norton’s ISC - were all built the old-fashioned way.

Key Tronic and ISC, which is now Olivetti North America, were founded by local entrepreneurs who had ideas and built their companies over a period of years, largely with internally-generated cash.

But high-tech start-ups today typically are high-risk firms that require high-risk investors like venture capitalists. And venture capitalists aren’t in it for the long run.

“From my perspective, the right time horizon is three to five years,” says Simpson, who sits on Packet Engines’ board of directors and runs Spokane’s largest venture capital fund.

During that time frame investors will want to take their profits.

“I don’t think there is any difference between Packet Engines and any other venture finance company,” Simpson says. “We are all focused on building a great, solid, profitable business, but at some point, whether it’s next month or in seven years, liquidity becomes important.

“And liquidity means you may have things like public offerings or a sale of the company that changes control and ownership.”

Company gets off to strong start

Regardless of how the story plays out, it has certainly started well.

Packet Engines is racing with 20 to 25 other companies worldwide to capture the market for products that allow computer networks to exchange information at rates 10 times faster than current state of the art.

The company, and indeed the market it hopes to serve, is the creation of Daines, a Silicon Valley expatriate who has returned to his home town to build Packet Engines.

Daines in the 1980s was a pioneer of personal computer networking technology. Those computer links exchanged information at 10 megabits per second, using ethernet technology. That rate of speed was fine for mostly text transmissions, but agonizingly slow to transmit graphics and imaging.

So Daines and his partners in Grand Junction decided to create 100-megabit ethernet technology hardware. Other companies tried to match the same speed using different technologies. But Grand Junction and fast ethernet won the market.

With ever-greater demands on computer networks, Daines decided to bet Packet Engines on his expectations that the day is soon coming when computer networks will need to operate at 1,000 megabits - or one gigabit - per second.

So in December 1995, Daines opened the door on Packet Engines in Spokane with five employees, and began trying to convince the high-tech world that it should begin laying the groundwork for gigabit ethernet.

At that point, Daines was a lone voice. Less than two years later, 100 or so companies have signed onto the formal process of setting the gigabit ethernet standards, and more than 20 competitors are racing Daines in the gigabit ethernet market.

Today, Packet Engines has more than 80 employees and appears to be leading that race. It is better financed than its competitors, has licensed several intellectual properties relating to gigabit ethernet products, and is ready to go into production on its first hardware products.

Setting that kind of pace takes lots of money. That’s why he brought in Fiske, Price and Simpson.

Daines funded the start-up himself, but six months into his venture, he needed a significant infusion of cash. Last June, two prominent venture capital groups, the Mayfield Fund of Menlo Park, Calif., and Battery Ventures of Boston, put up $7.5 million, in exchange for 42 percent of the company.

The previous year, 1995, set a record pace for venture capitalist investment. The industry poured $2 billion in early stage companies like Packet Engines. But by mid-1996 the pace had slowed considerably.

Daines’ history with Grand Junction, though, made Packet Engines a very attractive commodity.

“He obtained that first round of financing without even a formal business plan, which is just amazing,” Fiske says. “His reputation did it.”

By 1997, the direction of the company and its cash requirements were clearer. So the company sought its second stage of financing.

All the gigabit ethernet competitors were aiming for the spring Networld+Interop trade show, the industry’s premier event held in Las Vegas in May, where they would display their initial products, and hope to leverage those products into additional financing.

Packet Engines, though, wanted to be ahead of that crowd.

“We knew that after the Interop show that a lot of the gigabit companies would be out looking for money and we didn’t want to be just another ‘me-too,”’ says Price. “It was important to us to be the first out raising a second round of funding.”

Price and Fiske decided on a different approach on second-round funding. For initial funding, Daines went to the traditional venture capital community. For the second round, they decided to target institutional investors who normally would only invest in a company much later in its development. That required more sophistication.

They hired the prominent investment banking firm of Montgomery Securities of San Francisco to handle Packet Engines’ private offering. And they labored for two months over a detailed private placement memorandum to present to potential investors.

“That’s not an easy thing for a company in our stage of development to do,” says Price.

Typically, the focus of technology start-ups is dominated by the technology.

So the private placement memorandum was something of a distraction during a crucial technological development stage of the company. But Price thinks the exercise helps give Packet Engines the edge it holds over competitors.

“It forces all the key people in the company to really spell out what the strategies are and how they all fit together,” Price says. “How product strategy fits with marketing strategy and how that fits with the manufacturing strategy and the financing strategy.”

Investors were impressed.

They put $16 million into Packet Engines. The lead investor is GeoCapital Corp. of New York. Both the Mayfield Fund and Battery Ventures participated in the second round as well, along with Simpson’s Spokane Capital Management.

Investor value shows just how fast this world moves. First round investors bought 40 percent of Packet Engines for $7.5 million. Second round investors put up twice that amount, and got a much smaller fraction of the company. Price and Simpson won’t say exactly how much.

But investors’ willingness to accept so much less means that in less than a year, Packet Engines’ worth has grown far beyond its roughly $18 million valuation at initial funding.

“You can get so much money for having an idea,” explains Fiske. “But when you actually start bringing that idea to fruition, you are worth a lot more.”

And the investors are betting that the pace of the company’s growth - and its corresponding value - will continue to accelerate exponentially.

Money brings outside influence

Of course, the money isn’t free.

“One thing a company gives up when it takes in new money is the complete flexibility to run the business its way - because you’ve brought in a partner,” Simpson says.

Typically, significant investors receive seats on the board of directors, as have Mayfield, Battery and GeoCapital.

So who you take your money from can turn into a high-risk game as well.

“If things have been misrepresented, or don’t go according to plan,” Simpson says, “the investor has the right to take corrective action.”

In other words, a venture capitalist can become a pain in the neck if he is unhappy and starts meddling.

Extent of need tends to dictate flexibility in choosing investors with whom to work. Fiske says she has structured deals for companies that had to close the deal by next week to make payroll. “In those cases,” she says, “you can’t be too picky.”

Growing in the shadow of Grand Junction, though, Packet Engines is on the opposite end of that spectrum. The company could choose its investors, so they looked for those who could add more to the company than money.

In GeoCapital, Mayfield and Battery Ventures, Price says, they found vast experience and strong understanding of how high-tech start-ups are built.

The investors also brought critical connections that can help Packet Engines in its race with competitors.

“The lead group in this round of financing has a number of relationships with networking consulting groups on the East Coast,” Price said, “and they have already provided leads and contacts and some business strategies to us.”

Building value is primary goal

This high tech, venture-capital-fueled corporate building process puts the traditional evolution of a company on fast forward. Investors either lose or make ample amounts of money at a break-neck pace.

But where in this investment model are the local economy’s interests served?

For all its legendary success, Grand Junction Networks doesn’t exist anymore. It was sold and absorbed into the high-tech mechanisms of a much larger Silicon Valley company.

So would a highly successful Packet Engines be a long-term player in the Spokane economy? Would a buyer be content to let it continue its operations in a high-tech outpost like Spokane? Or would it whisk it back to the Silicon Valley?

Would taking the company public offer any more assurances of its longevity here?

Packet’s principals are not absorbed with these questions at this point.

“I believe the quick-return concept has a bad rap,” says Price. “Building value is the goal, and if a company goes public, or is sold, it means that value has been built.”

Regardless of its longevity, Simpson says a successful Packet Engines will leave an indelible mark here.

“This is something that’s terrific for this community,” Simpson says. “It demonstrates that there’s really no reason why a company from the Silicon Valley, or Seattle or anywhere cannot do something similar right here in our own back yard.

He adds: “I’d be willing to flash forward several years and say this is going to spawn other companies like Packet Engines.”

Packet Engines is drawing people with remarkable levels of talent to Spokane, he points out. The success of the company will offer them significant financial rewards. And regardless of where Packet Engines heads, many will choose to stay here rather than return to the more hectic lifestyle of bigger cities. And they will have the talent and resources to start their own companies.

“Look at Seattle,” Simpson says. “It was just a lumber and airplane town in the 70s. Then you had Microsoft and McCaw Cellular, and the success of those companies has fueled hundreds of other companies there.

“Spokane needs something just like that.”

, DataTimes ILLUSTRATION: Color photo