Washout Rains $53M on Pluris
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