Mining Risk Where Others Falter

P> Editor's Note: This is the third in a three-part series on the state of venture capital in the Washington area. Give us your comments, tips and suggestions as we continue to develop this beat. Send them to technews@technews.com with "venture cap" in the subject line.

Jerry Grossman would like to slip a message into some of the deep pockets of capital on the East Coast. "If you understand the investment risk attributes of government contracting firms and the technological firepower, and the brain power that's resident here, you'll bring your money down here."

"Here" is the ring of opportunity surrounding the capital. Grossman, Sr. vice president of Houlihan, Lokey, Howard and Zukin, the nation's 15th-largest mergers and acquisitions firm, said there are thousands of funds that might invest in this marketplace but don't -- out of ignorance or misperception.

Working out of an office in McLean, Va., Grossman's mergers and acquisitions firm invests in middle-market companies above the venture capital, or "mezzanine," stage. These established companies need capital to launch new ventures or fund management buyouts. Grossman said these companies range in size from $5 million to $10 million in revenue up to $200 million to

$1 billion.

A mergers and acquisitions firm rarely provides capital directly, but instead acts more as an agent that finds capital. They convince others to invest in established companies. Grossman is often on the phone explaining why big investors should look at the businesses that serve government differently.

"One of our current initiatives is to convey the nature and investment appeal of companies in this mid-Atlantic marketplace to the additional sources of capital who have some perceptions of firms in this region that are off the mark relative to reality," said Grossman.

"There are two things [big investors] shy away from," he said. "One is technology, and the other is government business. Our view is that is a very powerful combination, because those who know the government procurement activities and the government contracting environment see those businesses as having low to moderate investment risk. And frequently, the outsider who isn't educated in those businesses sees them as above average to high investment risk. The need is to bring the investment-risk perception of those capital sources in line with the reality of the risks that actually exist. These private equity investors need to get some more sense of the power of this combination."

Cultivating that sense hasn't been easy, especially with the recent government shutdowns. The region was on the news every night in a negative way. And hardest hit were not the furloughed federal workers who got paid, but the government contractors who didn't.

This news doesn't daunt Grossman's "educating" task. He's more bullish on the region than ever. "The whole nature of cost-reimbursement contracting, where if I spend the money the government reimburses me, is an extremely low-risk way of doing business," he said. "It's an extremely powerful set of circumstances, and there are too many capital resources that don't understand this."

Inaccurate perception is one thing; burgeoning opportunity for big investment is another. Grossman sees another prospect in the commercialization of technology and technical expertise developed by the government.

There, too, Grossman believes the deep pockets up the coast insufficiently appreciate opportunities to invest in the transfer of technical expertise and products. Thousands of individuals in the region have worked in professional services and systems integration firms on some of the most technically challenging projects anywhere.

One such project was the Internet. Another is the development of sophisticated information security and search and retrieval tools. Yet another is the satellite communications and imagery business, pioneered and subsidized by NASA and spy agencies such as the National Reconnaissance Office. Contractors involved in these projects and would-be entrepreneurs who worked on them as employees are eager to take their expertise into new markets. Many such efforts will fail, which is true of entrepreneurship in general.

Others will follow the example of companies such as Dulles, Va.-based Orbital Sciences Corp. and become huge successes. Orbital's CEO, David Thompson, was an employee of NASA, where he hatched his idea to provide a new generation of space launch and communication services. Now he presides over a publicly held aerospace company that had $190 million in 1994 sales.

"The fact is, what may be called technology transfer, the commercialization of technologies that have been developed and perfected by government contractors, is starting to happen on the ground, if you will," said Grossman. "Five or six years ago, that was very rare. The Internet is the sterling example of this."

Those companies that surround the capital are in the best position to benefit. "Many of the venturesome activities will come out of firms that are already in the government side of the business," Grossman said.

"When big investors get that, the smart ones start looking for a way to get their money down here," he said.