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The Good, The Bad, and The Ugly

By Michael A. Greeley

April 14, 2006 | Later this month, the venture industry will host its annual meeting in San Diego so that we can congratulate each other on another very successful year and gloat about all the extraordinarily valuable companies we helped build. A good time will be had by all, and we will leave optimistic that the coming year will be even better than the last.

So now for “The Good, The Bad, and The Ugly...”

This is important for entrepreneurs to know. Venture capitalists feel pretty good right now. While it is still true that it is easier to raise $10 million than it is to raise $3 million, and there are still far too many practicing venture capitalists, if you have the next big idea, the market reception you should receive will be warm and cordial. Which is much better than the hostility of a few years ago.

This year industry analysts are pegging total funds raised by VCs to be approximately $25 billion, which augurs well for the funding environment for entrepreneurs contemplating raising capital. We have clearly emerged from the nuclear winter of the last five years. But we are nowhere near the lunacy of 1999 when the venture industry raised in excess of $100 billion. Clearly, too much money is as dangerous as too little money in the system.

Other good news is that there are real pockets of important innovation in the early-stage landscape: powerful advances in the informatics field, with “intelligent” medical devices, in material sciences, in alternative energy, in wireless communications, and in the open-source arena. Quality entrepreneurs are coming out of their bunkers, strong technical talent is readily available, and notwithstanding some ominous indicators (energy prices, rising interest rates, massive budget deficits), the general economic environment is comfortable.

Structurally, though, the venture industry is still in transition. There are arguably still too many funds operating; it is hard to shutter a venture fund given the 10-year commitment Limited Partners are making. As you consider selecting a venture firm to work with, make sure you understand where it is in its fund-raising cycle and that the firm will have the ability to raise additional funds to support your growth. It was estimated that there were between 10 and 12,000 venture capitalists investing in 2000; this number is probably closer to 7,500, but the number of firms has largely stayed constant. Cynical observers of my industry feel that the headcount will still drop to be around 4,000 VCs for the industry to be consistently profitable again.

The bad news, though, is that venture funds operate with a much lower tolerance for risk now. VCs tend to be looking for companies that “check all the boxes.” That is, a complete team needs to be in place, meaningful early customer revenue should be in hand, and product development roadmaps fully articulated. With increasing fund sizes, investors are seeking opportunities that require (or could tolerate) larger amounts of capital so that funds can be deployed more quickly. So, from an entrepreneur’s perspective, a “capital gap” is emerging. One positive outcome of this, though, is that median pre-money valuations have crept up from around $10 million in 2003 to closer to $17 million in 2005.

So now the ugly. Liquidity is all but nonexistent. Last year, less than 60 venture-backed companies went public of the thousands that are funded each year. While M&A activity is improving, the large incumbent vendors have disproportionate leverage in the acquisition negotiations. The number of extraordinary acquisition multiples are few and very far between. The occasional “home run exit” is offset with the numerous bankruptcies or M&A transactions where investors sell the company for a loss or the common shareholders (read management) realize little to no return, certainly on the time invested as well as the capital paid in.

While the environment is improving, the issue of investor liquidity is a real one. VCs will not support a sector where consistent compelling exits are not evident. Unfortunately, the bio-IT field still suffers from this. But entrepreneurs will be well served to espouse a strategy of capital efficiency, fund to milestones, obsession with early customer revenues, and reasonable valuations. While venture capital financing is not for every business, when used properly with adult supervision, one can build important, valuable companies. But it is expensive money, so take only what you need for the next two years and be maniacal about driving customer engagements.

E-mail Michael A. Greeley at

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