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After 18 months of steadily declining venture capital investment--and ever-gloomier forecasts for the foreseeable future--entrepreneurs may finally have a good reason to hope for better times. For the first time since mid-2000, VC investment rose modestly in the fourth quarter of 2001 to $7.1 billion, according to the PricewaterhouseCoopers (PwC) "MoneyTree Survey," in partnership with VentureOne and the National Venture Capital Association (NVCA).
Overall, VC investing for 2001 was still drastically behind the previous year's capital free-for-all-down from $99.6 billion to $36.5 billion. But Kirk Walden, national director of venture capital research for PwC, says 1999 and 2000 were anomalies in VC history, representing investment levels historically unprecedented and completely unsustainable. He points out that in 1998, just before the dotcom balloon swelled to full size, VC investing had reached $19.2 billion. "If you take the Internet bubble out, you almost double the historical precedent," says Walden. "That's a healthy level of investment."
Still, VCs are just coming off a long period of hunkering down with existing portfolio companies during a time when liquidity options have been quite scarce. In Q4 2001, investment in early-stage companies remained below 20 percent-a number that typically stayed in the 30 to 35 percent range, says Jeanne Metzger, NVCA's vice president of business development. In a separate survey of 400 VC firms conducted by Fountain Hills, Arizona-based Profit Dynamics in October 2001, 55 percent of venture capitalists believed the level of investing in early-stage companies would decrease over the following 12 months because of the demands of existing portfolio companies and the poor economic conditions.
By comparison, 34 percent of VCs believed early-stage investment would increase due to the tremendous amount of capital sitting idly in VC coffers, according to Dee Power, vice president of Profit Dynamics. And Metzger adds that most NVCA member firms began reporting in December that they were starting to look at new ventures, though they're taking their time with their selection processes.
Battery Ventures, for example, spent most of 2001 making sure the companies it financed in 2000 and 1999 were stable and had the right business plan for the new environment. "Most of that's done now," says general partner Morgan Jones. The firm is now slowly and carefully turning its attention to new investment opportunities. "I don't think anyone is going to run off and make fresh investments without doing all the homework," he says.
According to Walden, VCs are now looking for companies with solid revenue streams, and they're willing to trade a relatively high, quick return for sustainable growth. "If you're a company that's been in business for a couple years and you have a revenue stream, then your chances are probably better than they were 18 months ago," he says.
Entrepreneurs still have to satisfy the traditional requirements-such as a talented management team, a high-growth market and the right product for the market's need-but they now must also prove their businesses' capital requirements match the current market environment, says Morgan. "You're not going to get funded today with a business plan that says you have to raise $100 million before your first sale. People are looking for much more conservative spending plans."
Where the Money's Going
The "MoneyTree Survey" results also show a renewed interest in software investing, despite a huge decline in investment-from 18.4 percent in 2000 to 10 percent in 2001-in retailing and distribution companies, which had been heavily involved in online retailing. "The majority of venture capital has always focused on high-tech-biotech, medtech, software and hardware," says Power, "[both] pre- and post-dotcom mania."
Still, the dotcom meltdown may have primed VC investors for opportunities outside perennial high-fliers. "Entrepreneurs need to screen venture capitalists by their investment parameters and look for those who say they will invest in areas other than tech, or who have actually invested in those areas," says Power, adding that most VC Web sites now contain lists of parameters.
Power and other experts agree the turnaround as far as VC receptiveness to new investments will be slow out of the gate, gaining momentum through 2002 and rebounding more fully in 2003. But fourth quarter 2001 numbers suggest that optimism won't be out of line. "To paraphrase Mark Twain, the rumors of venture capital's death are greatly exaggerated," says Walden. "The dotcom death, yes, but not all of venture capital."
C.J. Prince is a New York City writer who specializes in business topics and is the executive editor of Chief Executive Magazine.
- National Venture Capital Association
(703) 524-2549, www.nvca.org