Holland is also one of the rare venture investors who actually talk with CIOs. He recently surveyed five CIOs, asking them to outline their IT priorities for the coming year: Doug Busch of Intel, Cecilia Claudio of Farmers Insurance, Jim Milde of Pepsi (since departed for Sony Electronics Worldwide), Roger Mowen of Eastman Chemical, and Lars Rabbe of Redback Networks. Holland also talks with the press, and his conversation with contributing editor Peter Krass follows.

Q: With economic recovery still among America's Most Wanted, are CIOs even willing to look at startups these days?

A: There is some reluctance compared with three years ago, when people felt that the standard vendors were letting them down and were not leading the charge on some new-technology initiatives. Then, there was a lot more aggressive activity, and a lot more work being done, to look at startups.

But not all the CIOs are in that boat. Doug Busch from Intel says his company is still actively looking at startups for things like automation systems for some IT functions, knowing they are not available from his traditional vendors. Also, CIOs have to look at startups. As Lars Rabbe of Redback says, CIOs are responsible for promoting innovation within their companies. So they've got to be aware of what's going on out there.

Q: After 9/11, IT security moved way up on everyone's priority list. How is that playing out with startups and venture investing?

A: Cecilia Claudio at Farmers Insurance talks about how much energy her company spends on security. It is extremely vigilant on the topic of security. The company monitors hundreds of denial-of-service attacks a day, but hasn't had anyone tap into its systems.

From a venture perspective, however, I think security is a classic, overinvested space. It seems that everyone in the venture community thinks they have to have a security play--or two or three. The challenge is that when the sector becomes unpopular, as we saw with optical, it just collapses. People can't imagine that it would become unpopular. But what if the economy picks up, and some of their competitors pull ahead because they're being innovative in ways to generate revenue as opposed to protecting their assets? These things change. The venture community tends to overinvest in certain spaces, so there's some risk around that. In the next 18 months, I would expect to see a big fall in terms of some of the overinvestment patterns.

That said, there are some good companies in security. Security companies that have identified true points of pain within organizations--as opposed to being the hundredth intrusion-detection company--can do well. One company we've invested in is Vernier Networks , which is a pioneer in wireless security. People are moving to wireless networks, but the boxes don't come with any inherent security. Vernier can walk through a campus and identify hot spots for security, wherever they may be happening. People are so interested in wireless networking from their PC that they're bringing in rogue devices. They're buying them off the Net, from eBay, bringing them in from home, ahead of when IT is ready to deploy them. As a consequence, you deploy these networks and there's no security. So Vernier walks in with a robust security solution that solves that need. That's satisfying an existing pain point.

Q: What other technologies are emerging that address the pain points of CIOs and their organizations?

A: Roger Mowen at Eastman Chemical says his company needs real-time collaboration among workgroups. Some companies have attempted things around that, but he sees some terrific productivity gains and some good ROI to be gained from that.

Claudio at Farmers, again, has identified some needs around wireless applications. She's got thousands of remote agents working in the field. A number of companies are attempting solutions, but no one is the dominant player. So that's wide open for new companies.

Jim Milde, when he was still with Pepsi, had a similar issue. He had somewhere in the neighborhood of 20,000 trucks out there. He wanted an ability to extend IT to those trucks using wireless technology, whether it be specific programs adapted to PDAs, or whatever it might be.

Q: You mentioned pain points. Is that what CIOs are thinking about now?

A: This environment today is very similar to 1991. We've got a potential war on the horizon; we had a war on the horizon in '91. And there are other parallels. In 1991, it was a very difficult environment for startups. A lot of venture capitalists were sitting on the sidelines. There were not a lot of startups getting funded. Yet a whole generation of companies that were very successful came out of that timeframe. We're starting to see that happen again now. I like to say that when the water goes down in a lake, you can see the fish better. With this environment we're in now, we're seeing companies with much better business plans than we did, say, three years ago. Real businesses solving real points of pain. Software companies that are truly bootstrapped come to us after spending their own time and money, and they've got three customers and a pipeline of six more. That's more traditional venture investing, and the kind of thing we're comfortable with. We'll see more of that.

Q: Still, many IT vendors are seeing declining sales and profits. Do you see anything on the IT horizon that could jump-start the market?

A: There's a misperception that no startup is doing well, that no companies are buying products from new companies, and so on. Just as we all overreacted to the boom in 1999, we're all overreacting to the bust in '02. There are some good companies out there that are getting traction. However, companies with weaknesses in their business model or their technology are faltering, and we're definitely seeing that now. Innovative companies with deep and interesting technological solutions are going to break the high-tech industry out of its funk.

We've got some companies in our portfolio now that are doing great. One is Peribit Networks . They sell a network appliance that dramatically improves network performance in many dimensions--application response, capacity, and throughput. In a typical installation, companies see up to an 8x increase in private-line functionality. If you're a company with tens of millions of dollars in fixed networking costs, this is free money. A company like that gets a good hearing.

Another is Atheros , and it's one of the hottest startups out there right now. It pioneered the 802.11/a/b/g chip for wireless networking. When this company was seed funded, nearly four years ago by Foundation, it was actually a project at Stanford. Now the company is on fire.

Q: It seems the bar has been raised for entrepreneurs and startups. Is that discouraging entrepreneurs and, in turn, slowing IT innovation?

A: I keep telling people that great athletes are coming back off the bench. We're starting to see some terrific entrepreneurs coming back into the game. Whether it's because their personal net worth took a hit, and they need to do another startup, or because they retired and decided that at age 47, retirement really doesn't suit them. Those kinds of people--good leaders--attract good teams and good ideas. So we're seeing a much higher-quality flow of business plans than we saw, say, two or three years ago.

Our pace of investment today is very close to our historical average, which is about two projects per year per partner. And we have six general partners. So we take a lot of time. In our minds, it's a craft business.

So we may be coming into one of the best times to be a venture capitalist. Valuations are down; plant and equipment costs are down; talent's up. So from a startup perspective, this is a terrific time. Now, if you're trying to get a company into the public market, this is a pretty difficult time.

Q: So this isn't a bad time for entrepreneurs?

A: There's a mythology out there that startups are drying up, or that people don't want to be entrepreneurs anymore. But we see hundreds of companies. I've personally met with 175 companies in the last 13 months. That's three a week.

This is one of the classic times when startups happen. People are unemployed. They're thinking, "I could take a job with a public company that's barely hanging on, or I could take this idea I've been working on and build a team, raise some money. What do I want to spend the next three years working on--realizing a dream or grinding away at a place where I'm as likely to get laid off as I am to get promoted?" As a consequence, I would argue that we'll see a lot more startups.

Also, during the late '90s, the reality was that people could do a startup, or they could take any job, anywhere, at some inflated pay. So that pulled some of the potential pool of entrepreneurs. Some of those people are now realizing that the jobs are not that exciting, and they're looking for the excitement again.

Q: But what about the difficulty of going public? With the IPO market so quiet, how do you plan to make money on your investments? And, again, won't this slow the funding for innovative IT startups?

A: One, the IPO market will come back. It always does, so it's just a question of when. We don't think that goes away.

Two, mergers and acquisitions are still a viable path. A company that has terrific growth prospects and unique technology is always going to entertain offers. Some of the companies I've mentioned have already been approached by larger companies. The need in these larger organizations for new product lines and new revenue is insatiable. That never changes. So well constructed startups and good product lines and business models will always have a reasonable exit.

Three, from a venture perspective, you need to be thinking of a liquidity event in a four, five, or six-year time period from inception, not the two or three years of the recent past. We're going to see some stretched-out expectations, because companies need to get back to the old model of being out there for a while, getting profitable, and building a certain base of customers and revenue, before people will think of them as candidates for the public market. There's a lot of rationality returning to that market.

Q: You mentioned valuations earlier. How important are they to starting and growing an IT business?

A: For us, the original valuation of the company is critical. If we can get a company that's valued fairly, based on the expected outcomes, we can always do well. What has been hard--and it's just now starting to settle down--is getting entrepreneurs to realize what these valuations mean.

A software entrepreneur today who thinks his or her company is worth $15 million and wants to put $10 million in it, so it's $25 million post valuation--we spend some time with them. We work with an investment banker that tracks technology companies that are trading below their cash value. It's five pages in small type. The enterprise value of those companies is less than zero. So we say to the entrepreneur, "If you say you're worth $25 million, then we need to understand why. You're going to have to be the category leader; you're going to have to execute perfectly; you'll have all these other things that will have to happen." So we're very careful about that. Our most recent investments have been done at very fair valuations.

Q: We hear that most VC funding is going instead to second, third, and fourth rounds as a way to prop up earlier investments. Is that what's really happening? If so, what's the implication for IT-product pipeline?

A: You have to look more deeply. There were firms that over the last few years worked their portfolio pretty intensely to make sure their companies were financed, and as a consequence, were working with later stages. We were one of them. In our case, we got a lot of that work done in '01. Our companies are refinanced; their burn rates are very lean; their organization is down to the right size; and they're in a good position to wait out the market and be able to live off the diminished expectations of what they can sell.

Some venture firms pulled up and went into a hole. They said, in effect, "These are tough times, so we're just going to hunker down and deal with our portfolio companies." But we view that as a mistake. A well funded, well organized company with a really strong product line that's formed today is going to come to market in the next two to three years. By then, the overall environment changes, and they're coming into a market with a lot less startup competition. Those are attractive dynamics for us. We have to think what the market will be like in three or four years.

That said, anyone who got into this business in 2000 and went wild and funded five companies that year is probably feeling pretty bad right now. It's a "catch a falling knife" scenario. The key is to not go too wild on either end of the spectrum.

Q: What other IT areas getting funded now where CIOs can expect to see new products in the pipeline soon?

A: There are tons of areas. One is real-time business-activity monitoring. We've looked at lots of companies in that space. Another is Web services, from the management arena. We made an investment there in a company called Talking Blocks , and it's another example of how the bar has risen. It was bootstrapped by the founding team, who put a lot of their own money in. They came to us with existing customers and a pipeline; they came with existing product technology (they bought it from a previous company they had worked for), so they had a basis and a structure, plus a group of engineers ready to go. That's the type of startup we weren't seeing a couple of years ago. Then, people would just throw together five pages of PowerPoint and get funded, and then do the work afterwards.

Other spaces include data-center automation. We've looked at a lot of companies but haven't made an investment. We've also looked at some interesting applications software. But it needs to address a very specific pain point that is not being addressed--or not being addressed well--by the elephants. They need to be staffed with people who have deep domain expertise, so that if a big player decides to focus on that space, the startup won't be just plucked off without any effort. They'll be attractive because they're solving pain and selling software.