Ray of Hope?

VCs are optimistic about the coming year but are still holding on to their purse strings.
Magazine Contributor
4 min read

This story appears in the May 2003 issue of Entrepreneur. Subscribe »

Could it be? Is the light at the end of the long, dark venture capital tunnel finally flickering? It's hard to say, given that VC experts have optimistically speculated, with each quarter's decline in investing, that the industry had finally hit bottom. Unfortunately, the loud thud was never quite heard.

But recent numbers offer more fodder for those taking the optimistic view. After nine quarters of decline, venture investing in the fourth quarter of 2002 finished nearly flat from the prior quarter, according to the latest MoneyTree survey from PricewaterhouseCoopers (PwC), Venture Economics and the National Venture Capital Association. The dollars invested declined from last quarter by only $300 million to $4.2 billion, while the number of entrepreneurs funded--692--was up from 671.

Overall, 2002, with $21.2 billion of venture capital invested, finished at the same level as 1998 and at about half that of 2001. Because exit strategies are still out of reach and VCs can only guess how long their money will be tied up, the low dollar amounts being invested aren't surprising. Valuations before investment are still below what they have been, and terms for entrepreneurs are tougher than ever, says Tracy Lefteroff, global managing partner of PwC's venture capital practice.

Of those businesses getting funded, a greater number are later-stage companies and those seeking expansion capital, rather than start-ups. Jesse Reyes, vice president of Venture Economics, says VCs have always invested where the money was needed. "VCs are moving away from the risks of some start-ups and looking at companies that already have proven concepts but need capital," says Reyes. Of the later-stage companies that got funding in 2002, software companies got the most cash--just under $1 billion--with biotechnology ringing up second, at $671 million.

Experience Required
What's hot these days, according to VCs? No question about it: fully fleshed-out business plans; solid, experienced management teams; substantial first-year revenue and a proven marketing strategy. Jim Matheson, principal of Flagship Ventures, also points to customer validation, which he believes is "the most important thing you can have." Cambridge, Massachusetts-based Flagship now regularly interviews customers as part of its due diligence.

But those who seek VC money still have to cope with the bitter pills of depressed valuations and harsh deal terms, at least until the market picks up and venture capitalists see a greater possibility of recouping their money quickly. While it isn't clear yet--and likely won't be until uncertainty settles on the world stage--when we'll see a turnaround, a 2003 survey of venture capitalists across the country by Profit Dynamics, a Fountain Hills, Arizona, research and consulting firm, pointed to better times ahead. Sixty percent said the VC outlook for 2003 would be better or much better than 2002, while none of them predicted the environment would significantly worsen. Overwhelmingly, they cited an improved economy and equity markets as the reason for their optimism.

"It's a much better time than it's been for the last two years," says Dee Power, who, with partner Brian E. Hill, co-founded Profit Dynamics and co-wrote Inside Secrets to Venture Capital (John Wiley & Sons). "If I were an entrepreneur and wanted second-stage financing, I'd start looking for it now; last year, I would have tried to bootstrap."

In terms of getting in the door, and for those who don't have a referral from a trusted associate, VCs surveyed by Profit Dynamics favored networking most, followed by attending industry events such as VC conferences, and directly contacting VCs. The one option nobody suggested was using an online matching service, which surprised Power. "You'd think it would work, but VCs and angels say they don't use it," she says. "The personal factor is important for investors."

C.J. Prince is executive editor of CEO Magazine. She can be contacted at cjprince@chiefexecutive.net.


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