Venture Capital: Picking Up Pieces ; After String Of Bad Years, Investors Step Gingerly Into Market
Source: Denver Rocky Mountain News
Publication date: 2003-01-21
Arrival time: 2003-01-23
During the fever-paced heyday of the 1990s, there was perhaps no business more intriguing, and more patently "New Economy," than the wild world of venture capital.
What a wake-up call the past few years have been. For both venture capitalists and the companies they fund, the years have been replete with massive monetary losses and the inevitable layoffs and downsizing.
After licking their wounds and cutting their losses, some local venture capitalists said they're starting, if hesitantly, to enter the market once again.
To hear more about it, the National Venture Capital Association invited the News to sit in on a round table of VCs and entrepreneurs.
The participants include:
* Rand Lewis, senior associate with Centennial Ventures
* Art Zeile, chief executive officer of Inflow
* Bill Adkins, vice president of sales at Alignment Software
* Brad Feld, managing director with Mobius Venture Capital
* Tom Washing, partner with Sequel Partners
* Seth Levine, associate partner with Mobius
* Steven Bruny, chief operating officer of Connexn Technologies
* Bob Gentry, chief financial officer at Finali Inc.
* Jeanne Lazarus Metzger, vice president of National Venture Capital Association
Early in the conversation, Metzger steered the conversation toward the struggles venture capital- backed companies face trying to get new business in this economy.
Rand Lewis, Centennial: I'd say for venture-backed companies in general, what we're seeing is customers are asking the viability question much more than they were two years ago.
So, you know, two years ago it was the startup versus Microsoft. They were less likely to say, 'let me see your balance sheet, let me talk to your (chief financial officer) and make sure you're going to be around.' People are asking the viability question, and so that's a challenge that companies in our portfolio are facing today.
Art Zeile, Inflow: We found, (before) our last round of financing, that bookings tailed off pretty significantly because of financial viability. And we went through a financing where essentially we dropped our burn rate from approximately $2.6 million per month, I'm ashamed to say. But the good news now is that it's sub-$300,000 and declining.
And once we went through a very radical restructuring where essentially we took on 18 different projects simultaneously and eliminated 80 percent of the expenses associated with that burn rate, then magically there was an enormous amount of opportunities that were available to us.
Metzger: What role do (venture capitalists) play in your company?
Bill Adkins, Alignment Software: I came into Alignment just about a year ago and actually one of the motivations, reasons for me coming over was the proximity we had to Mobius, who is our primary investor right now. We're actually in their incubator, working out of the office. So for us it's a day-to-day . . . conversation and they are co-workers. And the state of the company that we're in, that influence is invaluable.
News: This closeness that you are describing, it seems like you couldn't possibly have done that with every company.
Brad Feld, Mobius: I've been an early stage investor since I started doing this, and I've always viewed my role as being integral to the creation of a company. When the market got out of control in the late '90s, the volume of companies and the volume of investments we were making definitely took us away from that; it took me away from that. And I had a number of companies where the amount of energy that I could put into the companies was limited just by definition of the number of companies I had. And we've corrected that. The market's helped us correct that.
Lewis: We've tried to be pretty strict about the number of deals that each investment professional works on, so we were actually pretty careful during the heady times to not get the number of companies that each principal was working on ahead of ourselves. So I would say, at least from our perspective, it hasn't changed a whole lot.
People might have been working on six deals; now they're working on four, but it's not really an order of magnitude. Certainly we're talking about different things. You know, as opposed to selecting the underwriters for the IPO, we're taking about WARN Act issues. Unfortunately we're talking about restructuring capital structures. But, I think the amount of time we're spending hasn't changed dramatically.
Tom Washing, Sequel: I think there's no question a couple of years ago everybody in the industry lost control of the traditional process that they were accustomed to because there was so much money being thrown at deals, and term sheets were getting closed so fast that there was this - I don't think panic is the right word, but we were all very sensitive to the fact that if you don't move fast, you potentially are going to lose what appears to be a hot deal.
I think the positive thing about what's happening today is we're back to the old process, which is much more methodical; people in general really don't particularly care if they lose a "hot" deal. They'd rather do it on their own schedule, have the time to do methodical due diligence and get to a decision that is in accordance with their traditional investment process, and I think that's healthy for the industry. At the end of the day I think we're back to where we were seven or eight years ago, and that's a good thing for the industry and for us.
Metzger: I know all of you have had to analyze your portfolios very carefully in the last couple of years in terms of deciding which companies to continue to fund and which ones maybe not to continue to fund. What were the factors that played into these decisions?
Feld: At the beginning of 2001 I went through my entire portfolio and I separated them into three categories: companies that deserved to live and companies that deserved to die and companies that I did not know. And the primary driver for "deserved to live" or "deserved to die" was whether I believed I could get economic return on new money.
So, I spent 2001 shutting down the deserved-to-die companies. Shutting them down, selling them off or whatever I could do. Trying to avoid the situation where you have companies that are hanging around that have no future but are still consuming time, energy and money. And nurturing the ones that were too early to tell, trying to get them to a place where you could make a decision as to whether you believed in them.
We (also) spent 2002 funding the companies that deserved to live and aggressively . . . cutting the expense structures to get the companies to a size that made sense.
At the time, I described 2001 as a year where every day was worse than the previous day. So by about July, I knew that that was just how it was going to be, so whenever I woke up I was just going to have a worse day. And it would stop eventually but I didn't know when. (And) I wouldn't say the the environment feels great today. It feels hugely great to sort of have that behind us.
Metzger: Now that all that triage is hopefully behind us, what kind of companies are getting funding now?
Feld: I don't think all this triage is behind us. We have 10,000 companies that are funded and operating today in a world where 2,000 should be. I think 2003 is going to be another year that has an awful lot of the same stuff that happened in 2002. It would be wonderful, but anybody that thinks it's over is just fooling themselves.
Metzger: But looking forward in terms of the new methods that you are incorporating, what are the key characteristics of those companies that are being funded?
Washing: This is a great time to invest into early stage companies. The last time Colorado had a similar experience was the mid-'80s when there was a major recession, technology and venture capital were viewed to be in great distress and that turned out to be a great time to invest. So these are good times to invest: There's a lot of great talent available, real estate space is very inexpensive, valuations are reasonable and so on.
Seth Levine, Mobius: I think that there's a misperception in the market that VCs aren't funding. I think that what's happening is that we're not funding as frenetically as perhaps we have in the past, but there are a lot of deals that are getting done. It takes a little longer to get them done, there's more diligence and more thought put into it, but they really are getting done.
Metzger: Capital expenditures have been the bottleneck (for a lot of) companies today. What is your outlook for capital expenditures?
Steven Bruny, Connexn: We don't see a fundamental change. We've seen capital budgets in the telecommunications industry cut substantially over the last two years, and one of the ways (we found is) that unless we had a message that would impact senior executives of telecommunications, we could not go in to midlevel people and expect (them to make) decisions on what to fund and what not to fund. So I think that one of the things that we've done and really put a lot of emphasis on is that for us to get some of the limited budgets that are out there is that our offering has to be strong enough that we can go to a CFO of AT&T or a Qwest or whomever, basically say this is something that really will affect your business.
Metzger: How has your company dealt with corporate governance?
Bob Gentry, Finali: I think all of us have to pay a lot of attention to it because the exit strategies are in the public markets. (So) I think we're all paying attention to what's going on in the world because it's going to affect us sooner or later.
Levine: We've seen a couple things happen. One is that we've been much more rigorous about setting up committees, audit committees, comp committees. Not only have we set them up, but they're actually being used, so whereas if they existed, they tended to be ignored in the past. Audit committee meetings are actually held and meeting with the auditor at the end of the year is a substantial meeting. It's not a 10- minute, "OK, everything's good." It's a full hour and, "Let's sit down and go through this." Management leaves the room for a little while, and it looks like it does at a public company. The other thing that's good I think is happening more . . . is there's been more focus on getting outside directors.
News: I'd like to hear more of the specifics economically of what you see happening in 2003.
Washing: I think the venture capital markets are like the public markets: They really don't like uncertainty. There's a huge amount of uncertainty out there still. Obviously the war issue and the implications of that are a huge uncertainty that's overhanging the market, and I think a lot of people feel, "Let's just get it behind us and get on with it." But we don't know what the implications of that are going to be on a worldwide basis. So I think that's casting a pall over the economy right now in terms of getting decisions done.
Metzger: With venture capital funding levels (down) pretty dramatically from where we were a few years ago, do you think that funding will stay the same or increase?
Feld: I think in Colorado you can see more funding in '03 than '02.
Washing: I agree with Brad. I think we'll probably do the same number of deals this year as we did last year, probably more.
Lewis: In our portfolio, we saw people starting to buy in the second half of '02 at a rate that exceeded what they bought in sort of the 12 months prior to that. I think that, especially in Colorado, but I'm also feeling it nationally . . . the triage is not over but 80 percent of it maybe is. At least the big bulk of it (is over), and so people are out looking fairly aggressively. And you're starting to see technologies that are so compelling relative to what the customers bought in the late-'90s that they will have to be adopted and the value propositions are just that much greater as technology marches along. I'm optimistic that IT service spending will increase in '03.
Metzger: What is your feeling or time horizon for liquidity for the existing companies?
Lewis: As we think about when the exits return, we don't think about the IPO market. We think about the acquisition market as those large multinationals that have gotten their houses in order, cleaned up their balance sheets and gotten profitable are now looking to grow but want to buy companies that bring high-growth products and services into their portfolio.
News: I'm curious how the companies feel about that.
Gentry: The IPO market is completely closed and it will be for a while to come, so if you're going to get liquidity, it's going to be that and it seems like this next year, most of those things will be either something that provides a huge amount of value or it's going to be a fire sale event.
Zeile: The intriguing thing about the environment is that these larger companies . . . are literally eliminating lines of business or product sets. And as we get into a better economic environment they're going to need more products to sell and they're going to be faced with the decision, well, do you revamp that line, do you restart it, or do you just acquire something that will plug the hole? So in my opinion there is an opportunity there for acquisitions when the economy turns around.
Lewis: You've sold a company before?
Zeile: Yes . . . The dynamic for me was that in my previous company, which I started with three other partners, we reached a point where we could not grow without having some kind of event happen to capitalize the business, and it happened to be the sale of the business. As to how it felt, it didn't feel that great, all things considered, in the sense that there were a lot of changes that happened rapid-fire. A traditional entrepreneur always feels like they have the right ideas, and it's a different relationship between the entrepreneur and the board or the investors than inside of a larger company.
Washing: One of the things in the venture business you learn to deal with is that you've got to put things behind you and move on. You are going to lose companies that are just heartbreakers, but at the end of the day you just get over it, put it behind you and move on to the next one. If you can't do that, you're never going to have fun in this business because it's not an easy business. Everybody suffers some pain along the way, but you put those things behind you and focus on things that are working.
INFOBOX
Who participated
* Rand Lewis is a senior associate with the Denver offices of Centennial Ventures. The venture capital firm has funded telecommunications and information technology companies including Inflow and Exabyte.
* Art Zeile is chief executive of Inflow, a Thornton-based company that provides Web site hosting. The company, founded in 1997, has 179 employees, about 700 clients and has received $320 million in venture capital funding.
* Bill Adkins is vice president of sales at Alignment Software. The Superior-based company, founded in 1996, makes transaction- monitoring software. It has 25 employees, has received $4 million in funding and currently has no clients.
* Brad Feld is a managing director with Mobius Venture Capital. The Superior-based company's portfolio includes dozens of technology companies, ranging from E*Trade to Alignment Software.
* Tom Washing is a partner at Boulder-based Sequel Partners. The venture capital firm specializes in early stage investments in companies including Connexn Technologies, CreekPath Systems and Finali Inc.
* Seth Levine is an associate partner with Mobius.
* Steven Bruny is chief operating officer of Connexn Technologies, which makes software that looks for areas where companies are inadvertently losing revenue. The company, founded in 1999 in Westminster, has 98 employees, more than 50 customers and has received $28 million in funding.
* Bob Gentry is the chief financial officer at Finali Inc., which provides outsourced customer service to other companies. The Westminster company, founded in 1999, has 300 employees, has received $31 million in funding and has about 10 clients.
* Jeanne Lazarus Metzger is vice president of National Venture Capital Association.
Rough years for venture capital
Top U.S. venture capital investments in 2002 by state through the third quarter, in billions:
1. California....$7.601
2. Massachusetts..1.976
3. Texas..........0.969
4. New York.......0.710
5. Washington.....0.474
6. New Jersey.....0.450
7. Colorado.......0.444
8. Maryland.......0.432
9. N. Carolina....0.397
10. Pennsylvania..0.377
Venture investments
In Billions
1990 - 2.9
2000 - 102.3
2002 - 22.0
Source: PricewaterhouseCoopers/Venture Economics/National Venture Capital Association Money Tree survey.
Publication date: 2003-01-21
© 2003, YellowBrix, Inc.
infobrix.yellowbrix.com |
