Which start-ups will win funding next?
By Neal Learner
Special to The Christian Science Monitor
from the December 02, 2002 edition
Want to boost your prospects for landing venture capital to fund a start-up in tough times?
Despite the recent dotcom bust, your best bet may still be a lean, customer-driven technology company based in California's Silicon Valley.
But be prepared to bring an airtight business plan and a gleaming résumé to the negotiating table.
"The more seasoned entrepreneurs, who have done it before are certainly getting a closer look in this environment than first-timers," says Bob Grady, general partner of the Carlyle Group, a venture-capital firm in San Francisco.
The soggy economy and volatile stock market has dampened entrepreneurial activity. Slightly more than $1 billion in venture capital was invested in early-phase start-ups in the third quarter of this year, compared with $9 billion in the first quarter of 2000, during the height of the dotcom boom, according to a recent MoneyTree survey, which tracks venture-capital trends.
Only 159 initial start-ups were funded during the past three months, down from 214 companies in the previous quarter, says the survey, released jointly by PricewaterhouseCoopers, Venture Economics, and the National Venture Capital Association. By contrast, 950 start-ups were funded during the early months of 2000, says Mr. Grady.
Grady says the first thing his firm looks for is a "strong and mature management team," followed by signs the company has already gained traction in the marketplace. Forging alliances with established companies can help. "We feel it is easier for a young company to sell - perhaps on the back of someone [established] - as opposed to going out and creating a sales force from scratch," Grady says.
"The big difficulty for start-ups is they need customer traction in order to get funded, and often they need funding in order to get customers interested in them," says Joel Wiggins, director of the Austin Technology Incubator at the University of Texas at Austin.
Mr. Wiggins adds that it takes more than simply a good idea to get funding in today's economy. "Companies need to live longer on their own money before attracting outside capital," he says. "This causes them to be more focused, frugal, and customer-driven. This is good."
Business incubators, which provide everything from office space and copy machines to technical support and financial guidance, remain a popular place for start-ups to hone their edge before seeking venture capital dollars.
Take, for example, the Center for Emerging Technologies in St. Louis, Mo. Currently 14 tenants - ranging from new start-ups to companies with 90-plus employees - occupy the 92,000 square-foot facility. The center focuses on helping biomedical start-ups, says Marcia Mellitz, president of the center that is affiliated with St. Louis University, Washington University, and the University of Missouri in St. Louis.
Raising money has not been easy for these enterprises, she acknowledges. "They haven't been the real sexy ones like the dotcoms," Ms. Mellitz says. "But on the other hand, they are all still alive. They have weathered the storm."
Indeed, start-up biotechnology firms saw the second-highest level of investment activity last quarter, with 18 companies receiving $137 million, according to the MoneyTree survey. Start-up software firms again attracted the most attention from venture capitalists, with 46 companies receiving $187 million.
Silicon Valley companies earned the lion's share from the dwindling funding pot, with 161 deals totaling $1.4 billion last quarter. The Bay Area region was followed by New England, with 81 deals totaling $560 million, and the Southeast, with 68 deals totaling $469 million. Overall, venture-capital investment declined 26 percent from the prior quarter.
Still, many experts agree the current contraction - if not carried too far - is not all bad.
A slower investment pace will let entrepreneurs and investors "build better-quality companies," says Allan Ferguson, general partner at 3I, an international venture-capital firm. "Good entrepreneurs are back in the marketplace and the ones looking to make a quick buck have gone to look elsewhere. We see this as a positive step."
For their part, venture capitalists know they may have to nurture a business for four years or longer before they see a return on their investments. That has led most to become increasingly selective, says Jeanne Metzger, vice president of business development and public affairs for the National Venture Capital Association.
But some experts worry that venture capitalists are becoming too cautious.
The formal venture-capital community "has pulled in its horns considerably," says Larry Cox, director of research at the Kauffman Center for Entrepreneurial Leadership in Kansas City, Mo.
"They no longer are throwing money at companies that had no chance of being profitable just on the strategy that if they could carve out a space, it would eventually become profitable," says Mr. Cox. "But on the other hand, you would hope that the pendulum wouldn't swing too far so that people are so cautious that they are unwilling to invest in really good ideas."
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