As printed in Fairfield County Business Journal, April
21, 2003
New Venture Capital is Available
By Edwin A. Goodman
The entire venture capital landscape has changed and entrepreneurs require
not only a new strategy but a whole new attitude about the company building
process.
The only constants in the equation between the 1990s and the current environment
is that, despite perceptions that the VC world has ended, there are entrepreneurs
fostering young companies and there is capital available for well-positioned
firms.
The biggest change is that the "American Dream" that I can make
it happen, build a company and get rich has taken severe blows in the
form of the retreat of the public equity markets, the corresponding evaporation
of initial public offerings (IPOs), the bursting of the Internet bubble,
the faltering of gross domestic product (GDP) growth, and the malevolence
of Sept. 11, 2001.
It will take some time for America and individual entrepreneurs to stand
up, dust themselves off, reconfigure their dreams and move on. Fortunately,
there are a number of promising stirrings in this respect.
Small is beautiful
In the 1990s, capital available within the VC world grew at an unprecedented
pace from about $5 billion invested annually in venture funds in the early
part of the decade to an aberrant $120 billion in 2000. The effects of
this flood of money were many, but the principal issue for entrepreneurs
was that money was plentiful and, like any other commodity, cheap. A young
company could raise a lot of it quickly and give up relatively little
equity.
Now, a young company can raise a little of it slowly and will have to
give up more equity than originally planned. So strategies must be adopted
to move forward in a parsimonious way and demonstrate that your idea is
viable initially on a limited scale. Lots of cheap money to finance rapid
growth along a broad front is simply not available.
Retrofit and refurbish
Generally speaking and in a similar vein, entrepreneurs offering solutions
that require their customers to make major capital expenditures will fail.
Corporate and consumer budgets are tight so it behooves entrepreneurs
to offer goods and services that deliver high return-on-investment for
the customer for relatively modest expenditure.
For example, it is virtually impossible to sell new switching gear to
the beleaguered telecommunications companies at this juncture, but one
can sell them software that accelerates and expands the performance of
their existing networks.
Money
Although as a consequence of the 1990's there is an unprecedented amount
of capital sloshing around venture capital coffers, this is deceiving.
Much of this capital is earmarked for assisting ailing portfolio companies
and much of it is being allocated on a highly selective basis to fuel
the growth of more mature profitable enterprises seeking to expand. Having
been bloodied in the debacle of 2000/2001, venture investors are inclined
to back later-stage, lower-risk ventures.
But contrary to much hand-wringing commentary, there is fresh money coming
into the industry. Venture funds raised about $20 billion in 2002, the
fourth-highest year ever. But still, early stage company founders and
chief executive officers have to think small.
Early stage venture capital rounds are currently being organized but
the rounds range from $2 million to $4 million and the operative underlying
premise is that the money will carry the company to positive cash flow.
This is a radical departure from the 1990's when the idea was to fashion
the financing to carry the company to the next larger equity financing.
That game is, for the foreseeable future, over.
Remember that in the post 1990's market, the entrepreneur must think
of the venture capitalist as the last stop on the fund-raising trail,
not the first. Exhaust your own resources and those of your family and
friends and angels in order to start and to establish some momentum for
your business.
In parallel, begin to cultivate venture investors and acquaint them with
your plans. Allow them to watch you and your company develop. Anticipate
a year-long or longer conversation before you cash a cautious venture
investor's check.
High-growth markets
Avoid macro thinking about the business environment and market opportunities.
These ruminations are distracting and only marginally relevant for fledging
companies. Although we would all prefer to operate within a robust high
growth GDP environment, of much greater importance is the growth of the
entrepreneur's selected addressable market.
If you select a high-growth area, you will, to some degree, be insulated
from a larger sluggish economy. Indeed, some markets are counter cyclical.
For example, companies that offer services on an outsourced basis frequently
do well in tough times when corporations are reluctant to invest in their
own less flexible infrastructure.
Currently, companies that offer a wide array of military products and
security applications to protect databases and communications networks
are prospering. Firms that offer no up-front capital investment combined
with the prospect of immediate cost savings for their clients are also
doing well. In short, try to align yourselves with the venture capitalists
who are always seeking markets of disproportionate growth potential.
Entrepreneurs who adjust their plans to the current realities will prosper.
Many of those who founded companies in the pervasive malaise of 1974 and
the recessionary environment of 1991/1992 realized great success in the
course of the subsequent five years. It will happen again.
---
Ed A. Goodman is co-founder of Milestone Venture Partners, which focuses
on early stage, enterprise information technology companies in the New
York metro area. He can be reached at (212)-223-7400 or eag@milestonevp.com.
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