By DAVID GEFFNER

Contributing Reporter

Bill Elkus discovered the Internet's commercial potential in an unlikely way. The year was 1997, and the Web was seen as not much more than a hobbyist's toy.


His son had been diagnosed with Celiac's disease an inability to process gluten that severely restricts diet.


"We were desperate to find more information," recalls Elkus, 55, the founder of Santa Monica's Clearstone Venture Partners.


"I started an Internet discussion group and our physician, who sees three cases a year, said we were wasting our time. Within a month we had 1,000 people signed up from 20 different countries. Suddenly hundreds of clinical trial patients were just an e-mail away."


With a background in private wealth management as president of Nathan Todd & Co., he set about convincing investors the Web was a solid bet. Elkus hooked up with Bill Gross, whose Pasadena-based Idealab would become an incubator for Internet hits such as CitySearch, eToys and GoTo.com, and started his first venture fund.


Elkus had an M.B.A. and a bachelor's in mathematics from MIT, as well as a Harvard law degree, but he had never been a venture capitalist. So he hired Jim Armstrong, who had a VC background, from Texas-based Austin Ventures.


Adding two more managing directors William Quigley, who specialized in early-stage communication firms at Mid-Atlantic Venture Funds, and Sumant Mandal, an entrepreneur from India Clearstone became the second largest venture capital firm in Los Angeles County.


In eight years it raised $650 million over three different funds, and earned the respect of institutional partners JP Morgan, Calpers and the University of California. The preference for risk-oriented seed and early stage investments has resulted in a who's who of tech-driven success stories, including Overture Inc., PayPal and United Online. Although the firm maintains offices in Northern California and India, it clearly thrives on being a big fish in a small pond: L.A. recently passed Boston in venture funding, but it's still just a quarter of the size of the Bay Area market.


"In almost every deal, we're competing with the VCs from up north, and trying to syndicate the deal with VCs in our own back yard," said Armstrong. "When you split a $5 million Series A investment, there's more dry powder and local influence over the company."


Armstrong, who has an M.B.A. from the University of Texas' McComb School of Business, started the Southern California Venture Association to promote syndication. "The argument I make (to institutional investors) is that L.A. has its own eco-system that the guys from up north can't cover with a plane flight," he said.


A typical Clearstone investment is in the individual as much as the idea, usually a technology entrepreneur. The partners are in for the long haul five to seven years in the $5 million-$15 million range with going public as the preferred exit strategy.


Armstrong says building a company for acquisition is "foolhardy" given changes in corporate buyers. Firms in the Clearstone portfolio that Elkus and Armstrong insist have the potential to be the next PayPal or Overture, include Presto, a computerless e-mail system developed with Hewlett Packard, and Santa Monica-based eForce Media, whose proprietary technology generates online sales leads.


Both men say Clearstone has excelled through integrity and an appetite for original thinkers. They backed Westlake entrepreneur Ron Burr and his three partners when NetZero, the predecessor to United Online, was still paying its employees in stock. Swallowing failure is another key: Elkus raised $118 million for a company called Real Names and lost every penny when Microsoft didn't renew the firm's contract.


"There's no shame in failure, as long as you can be honest about it, and move on," Elkus said. "It's very tough to get out. But your investors are buying into a pool of firms. If you can make twice the amount a failing company lost in less than half the time by focusing on a winner, you should be doing that."

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