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VC going stealth

Amid an increasingly competitive environment, many venture groups are doing what they can to keep their early stage investments under wraps. By Ken MacFadyen.

Venture capital and hype have traditionally walked hand in hand. The buildup begins with the initial investment and culminates a few years later with the initial public offering. At least that’s the way it used to work. Today certain groups have eschewed the hype for more of a secretive strategy, that of the stealth investment.

US Ventures and 3i poured money into stealth-mode Trovix, a maker of human resources search technology; OVP Venture Partners and TL Ventures backed stealth-mode Octavian Scientific, a semiconductor testing outfit; and Marc Andreessen has been making waves backing an internet company known as 24 Hour Laundry, also currently in stealth mode. These are just the stealth investments that have made news, as the concept, by its very nature, is meant to keep these types of deals under wraps.

The idea is that staying in the shadows, at least initially, gives companies time to sharpen their product before laying bare their intentions. Theoretically, it keeps competition at bay, and gives a business a longer gestation period before it’s time to claw it out with the competition.

Michael Gaiss, senior vice president, Highland Capital Partners

Highland Capital Partners, based out of Lexington, Massachusetts, is one venture group that has pursued a stealth strategy recently. Michael Gaiss, a senior vice president of marketing of the firm, estimates that roughly 20 percent of Highland’s portfolio is currently operating in stealth mode, representing a jump over past years.

“When you’re seeding a company, there’s really little value in broadcasting what you’re doing,” he says. “For one, you’re constantly refining the product, but if what you’re working on is unique, then there’s a greater chance that it will be copied by others. That means more competition for the business, which leads to more competition for top talent.”

As with most strategies, though, there are two schools of thought when it comes to the stealth strategy. Mark Fletcher, the founder of news aggregation outfit Bloglines, wrote a piece disparaging the practice on his blog Winged Pig in June. The entry, bluntly entitled “Stealth start-ups suck”, underscored the importance of “first mover” status for a company, and he also proffered the opinion that “There is no such thing as a unique idea”.

Google and Skype could serve as respective one-word counters to each claim, but Gaiss takes another tack.

With respect to the first mover advantage, he concedes that in certain instances, such as an internet company, there is clearly a benefit to being the first out the door. However, in other industries that’s not always the case. “If you’re going to sell a product to an IT organisation, you can’t just walk in there with something that’s half baked,” Gaiss says.

Meanwhile, Fletcher’s assertion that the new-idea well has run dry would imply that venture groups may as well pack up their things and go home. Gaiss counters, “Maybe there aren’t a lot of new ideas in the true sense of the word, but there are certainly new applications”.

Most venture capitalists expect stealth investing to pick up at a faster pace. The National Venture Capital Association echoed this sentiment in its forecast for the coming year, declaring that “The competitive drive may manifest itself in less hype and more stealth investing in 2006”.

The only question is if the strategy does gain momentum, will anyone even know?