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DEALIN' / Financing the State's Emerging Companies

Some VCs Shifting Focus to PIPE Line

As many start-ups struggle to hang on, funds are making private investments in public entities.


Just 12 months after U.S. went public, the Marina del Rey-based information firm was floundering and badly in need of capital.

With its shares trading under $5, tapping the stock market for more money seemed out of the question. So Chief Executive Brent N. Cohen decided to try another cash source: venture capital funds.

Cohen found a willing investor in Pequot Capital Management of Westport, Conn., which agreed to inject as much as $27.5 million in the firm.

Like U.S., other already public Internet firms, now grappling with layoffs, dwindling cash reserves and battered stock prices, are becoming good bets for venture capitalists looking to put some of their cash hoard to work.

That's a switch, because venture capitalists typically invest in private, early-stage businesses, expecting to cash out when the fledgling firms go public.

But recently, some venture funds that specialize in later-stage businesses are seeing value in troubled, already public companies.

"Many are just looking for a good deal--they don't care if it is private or public. The valuations here can make some of these venture capitalists very comfortable," said Bill Burnham, a partner with Softbank Capital Partners, a later-stage-investing fund of $1.5 billion.

Softbank Capital recently invested $4 million in Webhire (ticker symbol: HIRE), an Internet-based recruitment marketplace that went public in 1996. The fund also invested about $60 million in Global Sports (GSPT), an Internet-based sporting goods retailer.

"Sometimes the markets aren't rational. Some of these good companies see their stock price get dragged down with the other Internet firms, and don't deserve it," Burnham said.

Venture investments in public firms are known as PIPEs, or Private Investment in Public Entities. The idea isn't new--some funds have been doing it since the 1980s, according to Jess Reyes, an analyst with Venture Economics, a New Jersey data firm.

"But we've seen significantly more PIPEs recently," he said. More funds are viewing PIPEs as "a way to leverage those stocks that are at cheap valuations."

PIPEs can be structured in various ways, including as private placements of stock. Any ownership stake taken by a venture fund naturally dilutes the ownership of existing shareholders, just as a secondary offering of stock would.

The trade-off for diluted public investors, of course, is that their company gets a capital infusion and, in many cases, advice from the venture investors on how to improve the business.

Besides Softbank, other venture funds getting in on the action have included Technology Crossover Ventures, a Silicon Valley venture fund that recently put $50 million into Expedia (EXPE), a Bellevue, Wash.-based online travel services firm. TCV holds a 7% stake in the firm, whose shares have plunged from a peak of $65 to $9.50 now.

Pequot Capital's investment in U.S. (SRCH), made via Pequot's private-equity unit, involved the purchase of preferred shares. In addition, Pequot agreed to buy 3.5 million shares of U.S. owned by the company's largest shareholder, Kushner-Locke Co.

Combined, the transactions will make Pequot the largest shareholder in U.S.

Formed in 1994, U.S. provides public records information about people and companies, specializing in employment screening, asset verification and people- and business-locating services.

The company went public in June 1999 through lead underwriter Bear, Stearns & Co. at $9 a share, but the shares tumbled below the offering price on the first day. Though the stock later rebounded to as high as $12.38, it has since fallen to 81 cents a share on Nasdaq as of Friday.

"Like a lot of Internet companies, I think the infrastructure here and other things weren't really ready for the public markets," said Cohen, who joined the firm as CEO in February.

A former senior manager with Packard Bell NEC and with accounting firm Arthur Young & Co. before it became Ernst & Young, Cohen said he and other members of the company's new management team are trying to stabilize and redirect the firm's efforts in an increasingly competitive climate.

"That's a flaw in a lot of these Internet companies that are started by very young people: When things are good, it's easy to manage, but when things are difficult, you need more experience," he said.

The company, with about 260 people, continues to operate in a sea of red ink, though it says it hasn't had any layoffs. For the first six months of this year, the firm pulled in $13.4 million in revenue, almost double the year-earlier total. But the firm's loss from operations ballooned to $16 million, almost triple the year-earlier loss.

Pequot executives, who knew Cohen before he joined U.S., said the company complements other investments in their portfolio.

"We are focused on e-business," said Rick Heitzmann, a senior executive with Pequot. "And the products U.S. offers break down barriers and are a cure for a lot of the fraud problems in e-biz. We see a lot of value here."

Cohen said Pequot has provided not only capital, but also management savvy, connections to other companies in Pequot's portfolio and other expertise the company desperately needed.

"We're trying to refocus the company on the areas that are most lucrative and put basic business principles in place," he said. "This investment helps us through this tough period we've had. We've made tremendous progress."


Debora Vrana covers investment banking. She can be reached at or at Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.

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