Hitching a Ride.

BANKS LATCH ONTO VENTURE-BACKED COMPANIES TO JAZZ UP RETURNS

WINSTON Damarillo has a company that is only six months old and certainly isn't profitable. But he is in a position many small-business entrepreneurs would envy: banks are beating down the doors for his business.

Damarillo is founder and chief executive of Gluecode, a Santa Monica-based software company that recently raised $5 million in its first round of venture funding and already employs 51 people. Right now, Gluecode is seeking a line of credit to finance some of its activities and is looking for a bank.

The company doesn't have much in the way of collateral yet. Nevertheless, Imperial Bancorp and Silicon Valley Bank are competing to be its lender.

Each bank is promising a substantial line of credit as well as various financial services. Imperial is even thinking about making a direct investment in the company, according to Damarillo. He will make a decision fairly soon on which bank to go with.

"We're still negotiating and evaluating," he said. "Both Imperial and Silicon Valley Bank have been aggressively pursuing us."

That's because both banks recognize that emerging technology companies have to deposit their venture capital money somewhere, and while some of these companies will go belly up, others will grow to become powerhouses that will avail themselves of the traditional banking services these institutions can provide.

At a time when venture capital investment is exploding in Los Angeles, local commercial banks are. getting in on the action by lending to startups like never before. A fraction of this is through direct equity investment in a company in the hopes that an initial public offering will result in a 1,000 percent return on investment, or more. Some of the activity consists of investments in venture capital funds -- putting a couple million dollars into the hands of a large and successful VC shop with a track record of investing in winners. But most of it is related to wooing these companies for lending and deposit services.

Some of this, of course, comes with risk. Technology startups are like any other new business, in that they are more likely to fail than succeed. Perhaps even more so than other industries, because Internet companies often are based on litfie more than a good idea without any track record to show whether they will be successful. But commercial banks are betting that the future of L.A.'s economy will be heavily tech-reliant, and that some of these companies will mean to the region what Microsoft Corp. does to Seattle or Intel Corp. to Silicon Valley.

"What is driving the bank is, we are completely committed to the Southern California marketplace," said Beth Kinsey, senior vice president and manager of City National Bank's technology group. 'This is where the Southern California economy is going; you need to be on top of what is happening with tech companies."

Kinsey heads up City National's recent aggressive move into lending to technology companies. Hired away from Silicon Valley Bank three years ago, she focuses on finding Internet, software and biotechnology companies in need of financial services.

Earlier this month, the Beverly Hills-based bank announced that its technology group was opening an office in Sherman Oaks to service tech companies in Los Angeles and the "101 Tech Corridor" that stretches from the San Fernando Valley all the way up through Santa Barbara along the Ventura Freeway.

The group already has offices in Irvine and San Diego, and plans to open a Palo Alto office to compete for business in the Silicon Valley and Northern California.

"There is almost unlimited demand" from local tech companies, Kinsey said. "We get approached all the time. The key is getting the right business plans."

City National is hoping to take a chunk of the emerging growth business from Silicon Valley Bank, which practically invented it, and Imperial, which has been the most aggressive and successful of the L.A. banks to go after this business.

"With the increased level of venture capital that's come into (Los Angeles) in the last couple of years, we've really ramped up our lending activity," said Chris Woolley, senior vice president and regional manager of Imperial's emerging growth division for the Pacific Southwest. "The value (for tech companies) of having long-term professional VCs and long-term professional VC lenders is more important than ever."

Silicon Valley and Imperial banks are No. 1 and No. 2 in emerging growth services, with City National bidding to become a legitimate third alternative, and others are getting into the act as well. Comerica Bank-California, the subsidiary of Detroit-based Comerica Inc., has also been working to woo tech companies, as has L.A.-based GBC Bancorp through subsidiary General Bank.

The venture spigot

Venture capital money continues to pour into Southern California, as well as to the rest of the region. According to auditing firm PricewaterhouseCoopers LLP, L.A. received more than $1.3 billion in venture financing in the first six months of the year, almost as much as the $1.8 billion invested for all of 1999. Following hard on the heels of the money are the banks, wooing the suddenly flush companies first for their deposit business and then to loan them money.

"It's really a depositary business at first," said Joseph Morford, a bank analyst at Dain Rauscher Wessels in San Francisco. "Once a client generates account receivables, then the bank can make a loan against those receivables."

That kind of collateral is viewed as too risky by larger financial institutions -- they don't need the deposit business or the headaches of lending to startups. Instead, the business is dominated by the smaller and mid-sized banks that offer more customer service and support.

In return for their up-front money, the banks increasingly demand stock warrants as a hedge against risk. Warrants are like options, and can be exercised usually six months after a company goes public. Imperial and Silicon Valley banks have been taking warrants for several years; City National only recently started taking warrants, as have Comerica and General Bank.

"Say there's a medical device company that's right on the cusp of making sales, and wants to have credit to ramp up their business," said City National's Kinsey. "We'll set up a line of credit based on the company's account receivables. Today, we get a warrant on every transaction."

Other small banks that are reluctant to loan to such risky businesses are nevertheless getting into the act by investing in venture capital funds. East-West Bancorp and Cathay Bank, which like General Bank have strong ties to the Chinese-American community, invested in Dynafund Ventures' recent $160 million fund.

Dynafund partner Tony Hung wouldn't disclose how much each bank has put into his firm's fund, but said it ranges from $500,000 to more than $2 million.

"They all recognize the same thing," Hung said. "A -- it is a good investment. B -- they hear about what's going on in their backyard."

Hearing what's going on is crucial, because without strong ties to the local venture capitalists, banks won't hear about the best deals and the hottest companies.

"The key to what we do is the relationships with the VCs," Imperial's Woolley said. "At the end of the day, not everyone has them."

The VCs' choice

Silicon Valley and Imperial get high marks from the local venture community, although other banks are mentioned as well.

"(Silicon Valley and Imperial) are specialists in tech lending, and you don't always have that," said Brad Jones, general partner at Red-point Ventures, one of the several dozen funds that Silicon Valley Bank has invested in. 'They know how to value companies."

Large banks, of course, aren't shying away from venture activity, they just do it in a different fashion. Instead of competing for the lending business of risky companies, they have fully owned venture arms that make direct investments, even starting companies from scratch themselves.

Los Angeles-based LivHome Inc., a home care service provider for the elderly, was started by Bank of America's BA Venture Partners, which has led two rounds of financing totaling $12 million. BA Venture, based in Northern California, simply saw a need to fill in the health care sector and brought on Michael Nicholson, a health care industry veteran, to do so. But the VC arm doesn't necessarily refer its charges to its parent bank for loans.

"Some of them (go to Bank of America)," said BA Venture General Partner Mark Brooks. "But we make introductions to other banks. BofA usually only does deals with established technology companies."

Indeed, the challenge for the mid-sized commercial banks is how to hold on to a startup's business after it goes public and becomes an international powerhouse with billions in sales and market capitalization. Silicon Valley Bank has traditionally stood back and watched as its clients switch to larger banks once they reach a certain size. Silicon Valley then merely redeploys its expertise to cater to the next startup. But with sizable commercial operations of their own, Imperial and City National aim to keep their clients for the long haul.

"We think we can stay with a company a lot longer," said Imperial's Woolley. "We have a full range of services, via our commercial bank, to offer."

That sort of sentiment appeals to Glue-code's Damarillo. Recently flush with cash, he doesn't yet need to secure a loan from a bank, and would like to avoid awarding warrants to whichever bank he chooses, although he acknowledges he probably will have to do so. At the same time, he's thinking long-term.

"If I look at my business two or three years from now, I'd like to deal with the bank that supported me earlier," he said.