May 7, 2004 4:00 AM PDT

Microsoft says no to venture investing

Microsoft's strategy toward venture investing these days can be summed up in a word: Don't.

After making several venture capital investments in the 1990s, the Redmond, Wash.-based behemoth now largely eschews taking equity stakes in start-ups, according to Dan'l Lewin, corporate vice president of .Net business development at Microsoft and the company's point person in Silicon Valley.

Currently, Microsoft has investments in only about three or four small companies, he said. One is Groove Networks, founded by Lotus Notes creator Ray Ozzie. Microsoft also recently placed $1 million with Nanochip, which is concocting a new type of nonvolatile memory.

That level of investment is "insignificant. It is more the exception than the rule," Lewin said during a meeting with reporters, adding that the company made a "meaningful number" of investments in the past.

Information on Microsoft's investor relations Web site underscores the change. Between 1996 and 1998, the company made about 11 investments a year in start-ups and in established companies such as Apple Computer. In 1999, the number shot up to 39, and the following year reached 41. But in 2002 and 2003, only one investment was made each year.

Instead, the company tries to bootstrap rising stars by providing technical support and marketing help.

The shift, which started in 2000, mixes diplomacy and practicality. Venture investments can bring potential conflicts of interest. Start-ups can feel compelled to disclose intellectual property prematurely, and the funding can lead to discord in existing partnerships.

Besides, the amount Microsoft or other large companies contribute through their venture programs can be insignificant over the long run.

"One million or 2 million (dollars) aren't going to make a difference," said Raj Atluru, managing director of venture firm Draper, Fisher Jurvetson. "They would rather have a dialogue."

Microsoft's current method for helping these companies is relatively hands-off. Initially, the software maker merely sketches out its strategic directions and generally only provides information already disclosed publicly. From there, developers are expected to build applications on Microsoft's platforms.

Then, if a company lands a major account, the relationship changes. At that point, Microsoft will provide direct technical or marketing assistance. Ideally, at the end of three years, the start-up will have created an application that relies on Microsoft's underlying software and is targeted toward a specialized market.

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Right now, there are around 30 companies that have come to this final point, while 70 or so remain in the incubation stage, Lewin said. Occasionally, Microsoft also buys companies.

The overall strategy does have exceptions. To ingratiate itself with China's leaders, Microsoft has created a couple of joint ventures in China and been an angel investor in companies like Linktone, a wireless company that started trading on the Nasdaq in March.

So that nobody misses the point, the "o" in the logo of Censoft, one of the Chinese joint ventures, also has a notch in it, similar to the one in Microsoft's logo. The Chinese investments are not included in those listed in the investor relations section of the company's Web site.

Microsoft's reluctance to invest differs from the approach taken by Intel, which has directly invested billions into start-ups.

Intel executives have said that the chipmaker's venture unit has helped jump-start new markets and uses for PCs. Companies that have received Intel funding include CNET Networks, the publisher of News.com (Intel has since sold its shares), and Groove.

Wade Woodson, a partner at Sigma Ventures who was invited to the meeting by Microsoft, said he believes that the arm's length approach works better.

"Microsoft's is the most helpful strategy for the venture community. The Intel relationship can be very confusing," he said. "There is no other company out there that puts as much effort to work with small companies as Microsoft."

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