SOMETHING VENTURED: Space, Silicon Valley's Final Frontier

By Mark Boslet
03/29/2000
Dow Jones News Service
(Copyright (c) 2000, Dow Jones & Company, Inc.)

PALO ALTO, Calif. – (Dow Jones) – Chief Executive Munjal Shah needed new office space for his rapidly growing Silicon Valley startup, but after three months of looking he had nothing in hand.

The Mountain View, Calif., property he had just seen wasn't perfect. But it was usable. The problem was the property had been on the market one hour, and already seven companies had made offers, including Netscape co-founder Marc Andresseen's Loudcloud Inc.

That's when Shah, who runs online auction software maker Andale Inc., said he received a critical phone call. Loudcloud was three hours late returning a signed contract, and if Shah could show up check in hand before the Loudcloud fax arrived the place was his.

"We got in the car and drove as fast as we could," Shah recalls. "The situation down here is so bad. It's not even funny any more."

It hasn't been humorous for months. As startups navigate from initial funding to long-term success, finding office space in hyperactive, land-starved Silicon Valley is becoming as critical as recruiting employees, designing products and securing customers. The environment has been noticeably more frantic in the past six months, and prices climb week to week, say venture capitalists, executives and real-state experts. Bids frequently go above asking prices, they say.

Landlords also know they hold the upper hand over desperate tenants and are demanding that most valuable of startup currency: stock warrants.

"It now becomes an executive decision to secure office space ... because you have to make a decision on the spot," Shah said.

It also has become a muzzle on some companies' growth.

Startups rent an office and "literally start looking for another right away," said Justin Segal, co-founder of Startups.com Inc., a consulting company for emerging companies. "It used to be finding money was the most difficult thing. (Now) finding space is one of the most important thing a company can do. It can literally mean the difference between success and failure."

Business leaders say finding the right space is critical for recruiting engineers, Web site designers and sales executives in the tight Silicon Valley labor market. Having an office that is convenient for the engineers living near San Jose and the graphics artists from San Francisco is a necessity.

Behind the recent office-space stampede is a 215.2% burst of venture-capital funding in Northern California that led the nation in 1999 and produced $16.9 billion in money for emerging companies. The result is that hundreds of rapidly expanding startups are scouring for office space in well-situated towns, such as San Mateo, Foster City, Redwood Shores, Menlo Park, Mountain View and Palo Alto. Many also are looking in San Francisco.

"What's the choice?" asks Farrokh Billimoria, general partner at the Sprout Group, Donaldson Lufkin & Jenrette's venture capital arm. "If you have an idea (for a company), what do you do?"

The boost in demand has sent prices skyward. Downtown San Francisco properties bring annual rental costs that range from $50 to $95 a square foot and which rival those in the business districts of New York City, company executives and real-estate specialists said.

Properties in popular Silicon Valley communities – Palo Alto and Redwood Shores are two of the more popular – frequently run from $60 to $85 a square foot, these experts say. Other towns aren't far behind, though prices do come in at $40 and below. At these levels, rents here outpace those in other areas of the country with large venture-funding communities, such as suburban Seattle and northern Virginia.

The market shows little sign of changing. The commercial vacancy rate in San Francisco is 3% while in the Silicon Valley county of San Mateo it is 1.7%, said Robert Bach, national director of market analysis at real estate service company Grubb & Ellis Co. In contrast, the vacancy rate in suburban Boston is 8%, and in Austin and its suburbs it is 6%, Bach said.

The Case Of The Shrinking Cubicles

Demand also appears unabated. Scott Martin, chief executive of software maker diCarta Inc., acknowledges that he could have moved his company to a south Silicon Valley town such as Campbell, where the rents are bit cheaper. But the recruiting challenge would increase to where diCarta "probably wouldn't be able to get the company off the ground," Martin said.

The shortage of work space keeps many fast-growing Silicon Valley startups from moving to larger offices as rapidly as they want. The result is cramped quarters.

Instead of Campbell, diCarta, a maker of software that manages business contracts online, moved in January to an 11,900 square-foot office in Redwood City, which it thought would last for two to three years. Growth has been so rapid that in eight months the company will be bumping up against the walls, Martin said.

Workers at one startup tell of a modest-sized office shared by three executives, two taking turns at the same desk. Elsewhere, conference rooms get turned into work space, and cubicles shrink to 3 feet by 3 feet. At a San Francisco company, an employee's office was in a stairwell, where he sat with a laptop and his library of books.

Rosen Sharma, co-founder and chairman of software Ensim Corp., said space has been so tight his recruiters conduct interviews while walking around the block. The walk takes about 22 minutes, roughly the right time for an interview, Sharma said.

The tight space also places people on edge, and "interpersonal problems have gone up," he said. Ensim also has had to convert its ping pong table to a conference table.

"You can really see the affect of people not being able to play ping pong," he said.

Perhaps more importantly, colds spread easily in such close environments. A couple of products have slipped off schedule because of sickness, Sharma said. Some prospective employees walk away from jobs because of the condensed work environments. Some companies say they have no room to expand.

The lack of "space inhibits us, prevents us from hiring as aggressively as we would like," said David Mathison, founder, chairman and chief executive of Kinecta Corp., a privately held provider of software and services that link publishers to Web sites.

Kinecta has 6,875 square feet of space in two buildings on the fringe of the South of Market neighborhood in San Francisco. The company had outgrown the space by the time renovations were done and employees moved in, in November and began looking for a new location right away, Mathison said.

It presently has 65 people but could be 90 if there was room, he said. Along with paying expensive rents, many startups end up giving large security deposits to landlords, sometimes upwards of a million dollars. Executives say the money could be better spent investing in their businesses.

They also have to plead with skeptical landlords who can pick and choose their tenants. Ensim's Sharma said he pitched the landlord of the Sunnyvale property he moved into in March with demonstrations and a presentation fit for a room of VCs.

"It was a full-blown exercise," he said. "It was hard-core pitching."

Even then, Ensim handed over warrants and stock options, and "not an insignificant number," Sharma said.