By Michael GreeleyMEMORANDUM
TO: The Would-Be Bio-IT Entrepreneur
FROM: A Sympathetic Venture Capitalist
RE: What Do We Do Now?
January 13, 2003 | Like it or not, the supply of capital is an important ingredient in the continued development of the bio-IT industry. Appreciating and understanding the forces currently at work in the VC marketplace can only help in raising capital.
|Bio·IT World proudly introduces Nothing Ventured..., a regular column that turns the spotlight onto the venture capital industry and future investment opportunities in the bio-IT arena. Michael A. Greeley is managing general partner of the East Coast investment portfolio of IDG Ventures, a global network of venture capital funds operating in North America, Europe, and Asia, with approximately $600 million under management. He can be reached at email@example.com.
Many venture funds today are at best distracted and at worst in disarray and functionally obsolete. Many analysts expect that more than one-third of the venture funds raised in the past decade will cease to exist once their current commitments expire. Venture funds are restructuring and downsizing, and general partners are being let go. The sobering truth is that nearly 20 percent of early-stage companies that raised capital in the years 1999 and 2000 have already filed for bankruptcy. These trends constrict the amount of capital that is available to emerging sector funds such as bio-IT.
However, some encouraging counter-cyclical trends are beginning to emerge. Recent venture financing statistics indicate that, for the first time since the mid-'90s, activity during the past quarter in the life science sectors outpaced traditional IT sectors. This is due in large part to the severe correction in traditional IT sectors, particularly in the telecommunications field, but also because the venture industry recognizes that innovative products and services are being developed in the bio-IT space. Bio-IT business models often mirror traditional IT models, which imparts some familiarity to IT venture capitalists. Many of the larger venture funds already have teams focusing specifically on the life science and IT sectors; thus, they are able to pool their resources to better analyze opportunities in this rapidly converging sector.
The challenge now for would-be entrepreneurs is how best to access this source of capital. Clearly, many of the tactics utilized over the past five years are no longer appropriate. Fund-raising today is measured in quarters, not months or weeks, and in this environment it is far easier to cut costs or defer expenses than to raise capital. Venture investors are obsessively focused on burn rates and cash runways. Before this current correction, venture investors liked to see at least 12 months of available cash on the balance sheet; now, however, it must be a fully funded plan or have at least two years of available capital. There is no presumption of new sources of funding from other institutions; business plans are focused on a limited set of incremental objectives versus grandiose strategies. All of this results in smaller rounds at lower valuations.
Near-Term Revenue Streams Needed
For the entrepreneur, the composition of the venture syndicate is critical. Funds are no longer demanding to "take the whole round." Entrepreneurs should ensure that the venture firms they are approaching have relevant experience and relationship networks, are well capitalized, and have adequate reserve policies so that, as a member of the syndicate, each firm will be able to fund its pro rata in successive rounds (because there will be successive rounds).
The role of corporate partners in financing strategy is also evolving. Historically, corporate partners were used to price the last pre-IPO round and to lend some validation to the technology and the creditworthiness of a company. Today, these same investors are introduced earlier with the goal of creating near-term revenue streams, which the venture community will value highly as a meaningful milestone. Of even more interest to the investor is whether early customers are willing to prepay for the product, or at least pay close to the list price.
So, what now? Before approaching the venture marketplace, it is essential for would-be entrepreneurs to have a business strategy that clearly articulates potential customers' problems and how their products would directly address these problems. Appropriate and realistic sizing of the available market, even if it turns out to be a small market, is needed to demonstrate a thorough understanding of the competitive landscape. It is critical that the management team and the advisory board reflect the skill sets necessary to execute this business strategy.
Despite enormous industry turbulence, successful entrepreneurs should be inherently optimistic. The bio-IT sector is one of the few industries today that demonstrates such promising innovations, generates new products and services, and is matched with well-capitalized potential customers with obvious "pain points" that urgently need solving.