Venture Capital Hits A Difficult Spell

Tuesday, June 10, 2003

Robert Mamis, CFO, http://

Venture Capital Hits A Difficult Spell

Abstracted from: The Dry Season

By: Robert Mamis

CFO - April 2003, Pgs. 49-52

Tough times continue. Companies seeking venture capital, whether for startup or continued growth, should expect tight purse strings and stringent terms from VC firms still smarting from 2002's disastrous returns, reports Robert Mamis. Between 1999 and 2003, venture capital investment in expansion-stage firms has shrunk from $30.8 billion to $13.3 billion, according to one survey. Yet expansion-stage companies, which received 65.2% of venture capital in the fourth quarter of 2002, fared well compared to others. Startups accounted for just 1% of total venture capital during that period, while early- and later-stage companies received 17.9% and 15.7%, respectively. Battling against shrinking returns, some struggling VC firms have just shut down; others have slashed staff, slowed financing, weeded out cash drainers, and shifted their focus from early-stage companies to more established ones. VC investing dropped from a high of $106.4 billion in 2000 to $21.2 billion in 2002, according to the Venture Capital Association, although it still greatly exceeds the levels of the early to mid-1990s.

Companies needing capital still in limbo. Laggards remain in many VC portfolios but receive only enough cash to continue operations. FurnitureFan, an online furniture shopping service, had three rounds of financing between 1999 and early 2001. Still without positive cashflow, it has been unable to secure an additional round. Even so, its venture capital firm, Zero State Capital, continues to bridge the gap between revenue and costs. Some investments that might have closed long ago continue to get funding because the venture capitalists do not want to show losses, particularly when they have so few winners to serve as offsets. In this uncertain environment, the author notes, startups face the most resistance from VC firms.

The cautious atmosphere threatens to stifle the emergence of new small-cap companies, a critical component of a thriving economy. Also facing a cold shoulder are companies seeking to expand, unless they can show a broad base of customers and real revenues.

Making the best of it. Low valuations and tough terms prevail for those that manage to obtain financing, as venture capitalists are investing less money but demanding more equity. Nashua, NH-based Ovation products, which creates distilled water from effluent, was valued at $15 million back in 1999, when it raised $1.8 million. The company's valuation dropped by about two-thirds two years later, even though the team and technology remained essentially unchanged. One venture capitalist contends that entrepreneurs who manage to obtain financing should accept what may seem like onerous terms for the sake of stockholders and the company. Advises the author, that may be a wise decision in light of the harsh realities of today's marketplace.

Abstracted from CFO

published by CFO Publishing Corp.

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