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Washout Rains $53M on Pluris

Light Reading
News Analysis
Light Reading
2/20/2002
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Five is the magic number. That’s what core routing startup Pluris Inc. hopes. The company has just closed its fifth round of funding in five years.

This morning the company expects to announce it has raised $53 million in new funding from several of its current investors. It had raised more than $162 million prior to this round.

Unlike its previous funding rounds, Pluris has been forced to agree to what is called a "washout" or "cram-down" round of funding. This amounts to a reorganization of the capital structure of the company, heavily diluting the previous equity investor stakes as the company prints up massive amounts of new stock. New employees and investors are motivated by receiving equity stakes with the new stock.

The company’s pre-money valuation on this round was somewhere around $30 million, says one source close to the company. This is much better than the $5 million valuation that Caspian Networks was said to be looking at in its recent search for new financing (see Washed Out in the Valley). But it's still a far cry from the $650 million post-money valuation Pluris was given in late 2000 when it managed to close a $100 million fourth round (see Pluris Preparing for Its Public).

Pluris, like many other late-stage startups, has found itself in a precarious situation. While the company claims it will have five trials in operation by midyear, it has yet to generate any revenue, after five years in business. What’s more, the core router market remains in a slump, with overall revenues dropping 4 percent in 2001, according to Infonetics Research Inc. (see Report: Core Router Market Falls 22%). And as market leaders Cisco Systems Inc. (Nasdaq: CSCO) and Juniper Networks Inc. (Nasdaq: JNPR) announce flat revenues, it’s no wonder that Pluris has struggled to find investors (see Cisco Beats Street; Growth is Flat and Juniper Meets Lowered Expectations).

“It’s hard for a small company to stay in business as long as Pluris,” says Paul Sagawa, an equities analyst with Sanford C. Bernstein & Co. Inc., who covers Cisco and Juniper. “I give them credit for being able to get another $53 million.”

Sagawa cautions that Pluris will likely have a tough road ahead. "The bottom line is that it’s not a pretty market right now," he says. "It used to be that you just needed a 360networks Inc. or some CLEC to get your foot in the door, but now those customers don’t exist anymore. And larger carriers are more likely to go with existing suppliers.”

Insiders J.P. Morgan & Co., ComVentures, and Crescendo Ventures led this round and structured the washout to reconstitute equity and give new investors and employees an incentive in the reformed company. Most of the company’s previous investors agreed to the new terms, but three did not: Lightspeed Venture Partners, which invested in the company’s original round in 1997; Bay Partners, which invested in Pluris’s second round in 1998; and WorldView Technology Partners, which had invested in the third round in 1999. (Disclosure: Lightspeed is also an investor in Light Reading.)

According to the unnamed company source, Lightspeed, Bay Partners, and Worldview were all unable to invest in this round because they weren’t able to “cross over." In other words, the fund they had originally used to invest in Pluris either has run out of money or has been closed. Instead of taking money from another fund within the firm to invest in Pluris, which could potentially cause conflicts among limited partners in each fund, these venture capitalists decided to pull out entirely.

While crossovers are a legitimate concern, some say it is often used as an excuse by firms that want to cut their losses. Fred Wang, a partner with Trinity Ventures, says a lot of venture capital firms are re-evaluating their portfolios and only continuing to back a handful of their current investments.

“If you look at the recent performance of winners in core networking and that market in general, it’s not a pretty place to be,” he says. “It’s not surprising that some of these guys don’t want to put their money in there.”

Representatives from Lightspeed, Bay Partners, and Worldview were not available for comment.

Clearly, early investors not willing to “pay to play” get hurt in this scenario. But former employees also suffer. What usually happens in a washout is that all the preferred shares in the company are re-issued as common shares. As a result, the new block of common shares dilutes the older shares. Employees who have left the company could see their vested shares diluted to almost nothing. Current employees will likely be okay, because they will be given the new shares.

Sources also say the company is not done looking for cash. It hopes to add another $25 to $40 million from new investors. With 230 employees on staff, the money should last it another 12 to 18 months, according to the sources.

— Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.com

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realdeal
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realdeal,
User Rank: Light Beer
12/4/2012 | 10:55:06 PM
re: Washout Rains $53M on Pluris
I am trying to figure out the math on this one. Maybe the investors could lend me their calculator.

Avici has a market cap of 87.7mil with customers, an install base and revenue. While Pluris has raised ~160mil to date. It does not add up- speculation I guess.
Route495
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Route495,
User Rank: Light Beer
12/4/2012 | 10:55:05 PM
re: Washout Rains $53M on Pluris
Well couple of investors saw the light and pulled out. Others are probably too attached to their earlier investment.
mrcasual
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mrcasual,
User Rank: Light Beer
12/4/2012 | 10:55:05 PM
re: Washout Rains $53M on Pluris
Avici has a market cap of 87.7mil with customers, an install base and
revenue. While Pluris has raised ~160mil to date. It does not add up-
speculation I guess.


Don't forget, when Pluris closed round 4 Avici had IPO'd earlier that year and had a peak market cap of about 7.5B.

At that point the return on 160 mil looked pretty good. Obviously, it doesn't look so good now.
skeptic
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skeptic,
User Rank: Light Beer
12/4/2012 | 10:55:03 PM
re: Washout Rains $53M on Pluris
Does this mean the vesting clock starts all over for current employees if they are issued new shares? How does this impact former employees. LR should do a better job explaining this so rumors don't fly around on these boards. Maybe a hypothetical example would be nice.
---------------

In their defense, these things are often
structured on a case-by-case basis. The
things to understand are:

1. Past investors and employees who are already
gone from the company will get hurt the most.

2. The investors know that some sort of employee
equity has to be preserved to keep the startup
viable. The option pool will be adjusted to
keep employees happy (usually).

3. The option pool often ends up being
"redistributed" in the process. Performers
are rewarded, non-performers are not.

-------------------


Seems to me that doing a washout is all but certain to lead to a mass exit.

-------------------

But where are they going to go thats any better
right now? Current market conditions put most
of the leverage in the hands of the investors.


The_Holy_Grail
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The_Holy_Grail,
User Rank: Light Beer
12/4/2012 | 10:55:03 PM
re: Washout Rains $53M on Pluris
LR wrote "Employees who have left the company could see their vested shares diluted to almost nothing. Current employees will likely be okay, because they will be given the new shares."

Does this mean the vesting clock starts all over for current employees if they are issued new shares? How does this impact former employees. LR should do a better job explaining this so rumors don't fly around on these boards. Maybe a hypothetical example would be nice.

Seems to me that doing a washout is all but certain to lead to a mass exit.
skeptic
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skeptic,
User Rank: Light Beer
12/4/2012 | 10:55:03 PM
re: Washout Rains $53M on Pluris
I am trying to figure out the math on this one. Maybe the investors could lend me their calculator.

Avici has a market cap of 87.7mil with customers, an install base and revenue. While Pluris has raised ~160mil to date. It does not add up- speculation I guess.
----------------------

Avici also has an old system, is not welcome
in number of places, and has demostrated total
inability to add customers. Part of what this
says is that many people are dismissing avici
as a next-generation large router solution.

If Avici had a good product and good relationships
with customers, they would own the market and
nobody would be funding new companies in this
space anymore.

I can't really defend the economics of Pluris
though. They have been around forever with
less to show (by far) than avici does. The
best skill in the company seems to be convincing
investors to put yet one more round in every
time they look "dead".


The_Holy_Grail
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The_Holy_Grail,
User Rank: Light Beer
12/4/2012 | 10:55:02 PM
re: Washout Rains $53M on Pluris
"Most of the employees can't leave. Only some lucky people with lots of contacts have a chance at finding something else. But if you leave, you wont get more options.. so you are basically kissing away the last 2-3 years of your life"

Which is better, kissing away 2-3 years of your life and moving forward or giving up another 2-3 years of your life (for a total of 6 years) with the outcome still very uncertain? I read an article that claimed less 5% of the networking startups will ever turn into success (Can someone validate this? I'm not sure I believe that number). Also, what about diversification? Does it make sense to put all your eggs in one basket?

I just read in the San Jose Mercury News over the weekend that things may have bottomed out in Silicon Valley so if I was a company I would be looking out in the employee's best interest. Where would they go?
dietaryfiber
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dietaryfiber,
User Rank: Light Beer
12/4/2012 | 10:55:02 PM
re: Washout Rains $53M on Pluris
I think that people need to pull back from the concept that options will make you rich. This was true for the bubble period, but was generally untrue for much of the rest of the time. There were companies (Intel, Microsoft as examples) where there was significant equity gained across many people. However, how many of these companies are there? A startup (even say Ciena) is nowhere near as large or profitable as these industry giants.

Some people like to work in a startup environment and have the potential of bigger rewards than those working for large stable firms. This reward is unlikely to be the "instant millionaires" of the past 3 years. You may consider the risk/reward/sweat profile to be something you dislike. So, don't do it. If you worked the extra hours for $300,000 after tax after 3 years is that a good deal? Its clearly not life altering, but its a chunk of cash you would not otherwise have.

dietary fiber

Edge0fSpace
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Edge0fSpace,
User Rank: Light Beer
12/4/2012 | 10:55:02 PM
re: Washout Rains $53M on Pluris
Here's what happens when you start a union. Everybody gets paid the same. (Doesn't matter if you contribute more than the other guy, he still makes what you do.) No equity. You see GM giving stock options to assembly line workers? No!
To answer the original question, probably not. They will probably vest the new shares either, from the original grant date of the employee, or prorated. By prorated I mean, if the employee has vested 2years already then the additional shares will vest over the next 2 years. (Assuming a 4 year vesting schedule.) The latter is more likely.

E0S
elvislives
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elvislives,
User Rank: Light Beer
12/4/2012 | 10:55:02 PM
re: Washout Rains $53M on Pluris
Mass exodus ?
Where would they go ?

In the current market, when the VC takes advantage of you, the company has to say "Thanks, that was fun".

When the company, by its bad timing, has diluted all an employees shares, the employee has to say "Thanks, that was fun".

Most of the employees can't leave. Only some lucky people with lots of contacts have a chance at finding something else. But if you leave, you wont get more options.. so you are basically kissing away the last 2-3 years of your life..

So you look down, you take the new options they are giving you (which gives you 10% of what you had when you joined) and you keep working 60 hours a week. Otherwise the company will not meet its deliveries and will shut down.

I wonder what would happen if these engineers would regroup and form a union. Because the way things work right now, nobody looks out for the employee's interests.
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