1 - 7 June 2000

Business expertise: a must for tech start-up companies

Bank of America, the United States' largest bank with over US$650bn in assets, recently invested in a locally-based company, iWorld. The Bank's Chief Investment Officer, EDWARD J. McCAFFREY explains why the bank invested in the company. Interview by David Kelleher

The rush to invest in Internet stocks and dot.coms over the past 12 months has been enormous. The boom in Initial Public Offerings (IPOs) and the huge returns on even a small investment led many investors to part with their money in the hope of emulating others who became rich overnight.

It was probably one of the biggest mistakes that investors made because they failed to realise that many of the companies they invested in were not strong enough to face the competition and survive in the volatility of the markets.

Attractive websites and Internet offerings were not backed by a sturdy management team or a business plan that offered a good chance of success. However, despite the risks many took the plunge. The end result was that the stock markets could no longer continue hyper-inflating the value of tech stocks and this brought about a sudden slump in their value. The sharp drop registered by Nasdaq last month - by 36 per cent - was a sign that investing in dot.coms was not as safe as earlier thought.

What is interesting, however, is that the Nasdaq returned to the same level that it was at in November, before the craze began to invest in dot.coms and other venture capital companies.

"The public capital markets are very sceptical. After what happened over the past two months, investors are very wary of the tech market. They are very sceptical of the way IPOs are being offered," Bank of America's chief Investment Office, Edward McCaffrey told The Malta Business Weekly.

"The market is scared in a healthy way. The capital found its way into the tech stocks but investors soon learned a very important lesson. They learned that they could not only look at the cash and investment and, in some cases, a quick return. They also had to look at the company' business model," Mr McCaffrey added.

The drop in Nasdaq also taught investors a lesson and showed companies not to go public before they had developed properly.

"What happened to Nasdaq was very painful - both for the market and investors. However, its effect was positive and taught the market a lesson. Investing in tech stocks and companies is very risky and many failed simply because they had not developed enough to succeed," Mr McCaffrey told The Malta Business Weekly.

Similar investments are also a big risk to the individual and unless people are properly guided they stand to lose more than what they invested. The also risk personal ruin.

"The past few years we have seen a "herd" mentality, with everyone going to tech stocks. People saw what was happening, how the value of stocks were going and went to for it. They were misled by the market and failed to realise that at one point the bubble was going to burst. And it did," Mr McCaffrey explained.

So why all the interest in technology companies if the market is so shaky?

"Bank of America stayed away from investing in dot.coms because firstly, there was no successful track record to bank on and secondly, they were focused too much on the Internet and not on the business itself," he said.

"We are criticised and asked why Bank of America was not showing any interest even though the possibilities were enormous. We were, however, more interested in investing in companies and start-ups that had a strong business model, who had the expertise and stood a chance of surviving," Mr McCaffrey explained.

Bank of America did not sit back and waited for the market to stabilise. On the contrary it turned its investment focus on other areas that in the medium-to-long term would be more important.

"The bank turned its focus on start-up companies that showed promise. For this reason Bank of America

Equity Partners was set up. Bank of America Equity Partners was set up is the bank's internal private equity group. BAEP invests in emerging technologies and growth opportunities on a global basis and has over US$6bn in committed investments. We have seven partners - four in the US. The other three focus on Asia, Latin America and Europe," Mr McCaffrey explained.

The aim behind setting up BAEP was to do business with technology companies that had a particular specialisation. This led to the development of the Tech Venture Partnerships.

"We did not want to do it alone but sought the very best of breed. This was launched four years ago and we started primarily in Europe," he added.

Why Europe? "There were two things missing in the US. There was no single standard and less focus on applications. In Europe, however, we found people who had a vision and were experts in their field. That is how we became involved with iWorld and Andreas Gerdes.

"I had met Andreas in Germany and he talked about his plans to develop applications for mobile telephony. This struck a chord and fell in line with what we were looking for. Europe is still lagging behind the US in Internet technology, however the US focuses too much on the Internet. In Europe, the situation is different, moving towards mobile commerce and its applications," Mr McCaffrey said.

"Our partnership with the iWorld Group is based on a mutual vision of the impending convergence of mobile communications and e-commerce. Furthermore, Andreas has attracted an internationally recognised management team to iWorld and they have in turn structured an incubator process that optimises the probability for developing and nurturing world-class mobile e-business applications and services," Mr McCaffrey told The Malta Business Weekly.

"What we particularly liked about iWorld is that the people involved have a wealth of operating experience in the technology business. You need people who have been there and done it, experts in their own right," he added.

Investing in start-ups is always risk, no matter how good a business model that company may have, but Bank of America believes that if the idea stands a chance of succeeding, then it is worth it.

"Many start-ups came out with ideas that had little chance of succeeding. Investors were taken off their feet and willingly supported such ventures. However the only way to succeed is if you have the capacity and knowledge to do business. Technical expertise is not enough. That is why many will not survive," he said.

The bank, he added, realises that any investment carried a certain amount of risk, however in iWorld's case, the group fitted into Bank of America's model.

The fact that iWorld is based in Malta was not a problem either, although, he admitted, the bank did not have much background information.

"The location is irrelevant to the bank. It is another country to do business in. However, it is a great opportunity for Malta. The indirect effect of any investment here will be beneficial to the whole country," Mr McCaffrey told The Malta Business Weekly.

Edward McCaffrey has been Bank of America's chief investment officer for the past seven years. He has a background in corporate finance, specialising in small and large companies. He has been with Bank of America since 1975. His main focus is developing small businesses into large commercial enterprises. For the past few years, he has been working on start-up and technology companies.