With half its capital remaining from a previous round, connectivity specialist Neterion Inc. of Cupertino, Calif., has raised $18 million more in a second round that gave it an increase in valuation.

Expecting the dismal funding climate to continue, the 2-year-old company took advantage of a completed product road map and validation from potential customers to land the increased valuation from lead investor Menlo Ventures of Menlo Park, Calif.

Neterion still had about half its initial round of $9 million in capital remaining when executives and original backers VenGrowth Capital Partners and Business Development Bank of Canada decided last summer to eliminate the dreaded "Valley of Death" mid-stage fund-raising round and sound out investors about financing the company through a product launch to profitability. Neterion used no placement agent. It turned to Mark Davis of San Francisco law firm Kirkpatrick & Lockhart LLP.

The company is developing proprietary hardware and software that goes into boards that speed the input and output functions of large storage servers. It jumped into the market in September 2001 at the first signs that an ambitious industry-backed program to switch from Ethernet connections to a newly developed standard called InfiniBand might falter with declining overall spending on information technology.

Neterion launched product development to create boards to speed operations of large servers built by companies including IBM Corp. of Armonk, N.Y.; Hitachi Data Systems Corp. of Santa Clara, Calif.; EMC Corp. of Hopkinton, Mass.; Dell Computer Corp. of Round Rock, Texas; and Hewlett-Packard Co. of Palo Alto, Calif., with a strategy of selling directly to those manufacturers to create quick ways of improving the efficiency of their systems.

The company had expected to close this round later this year after initial product delivery had begun. But early interest in closing the round in advance of product launch and investors' interest in fronting a larger amount than originally anticipated convinced management to forego higher bids later in favor of boosting the company's balance sheet now.

"They have fully defined their products and validated them with potential buyers, and what sets them apart from other companies is the level of engagement with customers," said Glenn Egan, director of venture capital at VenGrowth. "They have the right design and the right timing, and we thought they would be in a better position with customers, with a strong balance sheet to back them up."

Increased traffic with ever-larger amounts of data is expected to create a need for improved input/output devices on storage networks, but development has lagged in expectation of a new industry standard. Virtually all of the largest server manufacturers and their suppliers threw strong support behind the new Infiniband standard of input/output in the late 1990s, but as server sales lagged in recent years, expectations for Infiniband have plummeted.

Vernon Turner of technology research firm IDC projected a year ago that by 2004, 80% of all server shipments would be InfiniBand and that revenue from InfiniBand devices would reach $2 billion by that time. But he said that he has since revised that projection downward three times in the past year, with adoption rates now pegged at between 3% and 7% by 2004, and revenue hovering between $66 million and $184 million.

Turner said overall spending on servers has been hammered by the current decline in information technology spending, and incremental spending to improve current systems is not a high priority. But he predicted a big boost in input/output technology spending when companies again budget technology upgrades.

"Unless we see a major uptick in spending overall you are not going to see information technology people spending on new infrastructure," Turner said. "But that will change because i/o technology will be the simplest way of making bandwidth denser on existing systems."

Neterion early on decided to concentrate on an Ethernet-only product, keeping Infiniband development on a back burner, and Zabrowski believes the company has benefited mightily from that decision.

"People are starting to realize that Infiniband is good on paper, but that it will end up a niche market," Zabrowski said. "A lot of people jumped on the bandwagon early and that caused some stalling in the development of products for existing standards."

That has opened a niche market for Neterion to concentrate on improving input/output speeds on products currently available. Turner said that could produce a strong short term advantage, but he cautioned that the window of opportunity could be brief if server manufacturers end up concentrating on a new standard.

Zabrowski firmly believes that InfiniBand will remain a marginal technology, but the company has hedged its bets, continuing development of InfiniBand products should the market emerge strong.

"If the market is out there it will quite easy for us to move into it," Zabrowski said. "But it is more of a tactical opportunistic question than a technology strategy."

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