From: Mike Masnick (mike@techdirt.com)
Date: Fri Dec 29 2000 - 10:57:49 PST
At 03:50 AM 12/29/00 -0800, Rohit Khare wrote:
<<stuff about seed funding drying up clipped>>
For the other side of the story:
http://www.thedeal.com/cgi-bin/gx.cgi/AppLogic+FTContentServer?pagename=Futu
reTense/Apps/Xcelerate/Render&c=TDDArticle&cid=TDD7KNWPAHC&preview=true
From another Red Herring writer saying that some VCs are focusing their
efforts on seed stage deals because the valuations are finally reasonable,
and the potential returns are very lucrative (due to those low valuations).
While I'm sure that there are a lot fewer companies receiving seed-stage
funding, I'd bet the quality of both the companies, and the investors in
those companies is going up...
-Mike
----------------
Heading south
by Peter D. Henig
Posted 03:40 PM EST, Dec-28-2000
Venture capital was never supposed to be easy.
It was always more art than science, and the best VCs never forgot this.
They trusted their nose for new deals. The worst ones never got it, dishing
funds out like junk food. Flush with cash and easy exit strategies, nouveau
VCs greased entrepreneurs for healthy equity stakes while basting in fat
management fees.
The market, however, is starting to congeal. And with it, VCs are suffering
down rounds, collapsed valuations and limited partners running out of
patience with poor investment decisions.
In Silicon Valley, this is all old news. But if you haven't yet heard, even
established venture firms such as Crosspoint Venture Partners are
abandoning their latest billion-dollar funds, deciding to take a pass on
the committed capital and concentrate instead on existing portfolio
companies.
Such funds Draper Fisher Jurvetson's much ballyhooed ePlanet fund --
forecast to be at least a billion dollars -- are running into brick walls.
With most VCs sticking to funding only the best of their existing
portfolios and allowing their weakest companies to die, the most compelling
deals, and the ones at which a new crop of smart money investors are
looking, are earliest-stage investments.
Even though the risk is highest, VCs and angels can invest at the seed
level at incredible valuations, allowing that the time for buildout of
these companies may actually help them weather the current slowdown in the
market and offer the opportunity for the IPO window to open up in the future.
In fact, many of the best brains in the venture capital community have
decided to pack it up and head south, back to their rich roots in funding
earliest-stage pre-business plan companies. It's a return to pre-revenue,
concept-only angel investing, a strategy that originally made venture
capital more fun than the pre-scrubbed mezzanine round funding it has become.
As evidence, some well-known names are scouting seed-stage entrepreneurs to
back. Charles Schwab and his sons are actively prowling the angel investing
market. Paul Stephens, founder of investment banking firm Robertson
Stephens Inc., has sniffed out a few early deals. The Gettys are actively
engaged in the seed-stage market.
Entrepreneurs, long leery of venture capitalists, love the attention.
"Having recognized names involved with the story has significant value when
you are struggling to get through the first three or four months of 'make
or break' time," says Tim Albinson, founder and CEO of ExchangeWave Inc., a
San Francisco-based startup building software and services for
business-to-business marketplaces.
"The stamp of approval for both the management team and business model
communicated by such investments is invaluable."
ExchangeWave counts Stephens, Michael Schwab and his Big Sky Partners fund
and a group of select Goldman, Sachs & Co. partners among his earliest
investors.
Such high profile angels are equally being joined by institutional money at
the earliest stages of company creation. Firms that never abandoned their
early-stage mission, such as Israel Seed Partners, are now finding the
company of such institutionally backed firms as Starter Fluid, a $30
million seed-stage fund that specializes in investments of $100,000 to
$500,000. (The University of Chicago, among others, is a limited partner in
Starter Fluid.)
In venture capital circles, such tiny investments are unheard of, reserved
for bands of angels who have already made their money. But unique new
venture capital models, like ITU Ventures, a seed-stage venture capital
firm that invests in and develops technology businesses emerging from the
nation's leading graduate schools, are more than willing to engage in the
high-risk, high-reward, long time horizon of investing at the angel round.
Nearly all other VCs have chosen to head in the opposite direction --
"upstream" or "north" as some refer to it -- opting for lower-risk,
later-stage deals that have already been scrubbed to death.
The current problem with later-stage dealmaking, and the enormous funds
supporting them, is that their value proposition makes no sense. They are,
in fact, dumb. Despite throwing off fat management fees -- 2.5% on a
billion dollars remains a nice piece of change -- they're pointless in
nearly every other regard.
To achieve massive returns on a billion dollars, a VC firm's portfolio must
reap billion dollar exit strategies across several investments, something
the IPO market, closed as it is, will no longer allow. Likewise, potential
technology acquirers (America Online Inc., Cisco Systems Inc., Nortel
Networks Corp. and the like) know they now have the leverage to negotiate
from a position of strength. And now that their own stocks have been
battered, they will be far more careful how they spend their equity.
At the same time, huge funds hamstring venture capitalists into making only
large bets -- anywhere from $5 million to $20 million in later-stage deals
-- where valuations are already high. If the company doesn't become a
billion-dollar play, nobody makes a profit.
"Later-stage funds are perfect when you want to hit a company on an upward
trajectory," says Robert von Goeben, founder and managing director of
Starter Fluid. "But smaller funds allow far more flexibility and a place
where you can build fatality into the model."
Von Goeben and others agree that a bifurcated private equity market has
been created within venture capital. It's no longer go big or go home. It's
go big or go small. And small is where most of the deals still are.
Although the pace of Darwinism is accelerating in the technology sector,
leaving even some compelling companies clawing for survival, with a $30
million fund, Starter Fluid can afford to make mistakes and still come out
ahead. An early-stage deal which is sold for a relatively modest sum --
even in the $50 million to $100 million range -- pays back the fund, and
then some.
Despite the compelling arguments, then, for "heading south," there remains
an "equity gap" in the market, a gap defined by Mark Van Osnabrugge and
Robert J. Robinson in their recent book, "Angel Investing" as the absence
of small amounts of risk capital, under $500,000, from institutional
sources for companies at seed-, startup- and early-growth stages.
Van Osnabrugge and Robinson note such early-stage investing has been deemed
uneconomical by the VCs in terms of the fixed costs of investment appraisal
and monitoring. They may have been shortsighted. Von Goeben sees not only a
future for his seed-stage firm, but also for others. "If you ask me,
there's room for at least five or six of us out here."
Peter D. Henig is a senior editor at Red Herring magazine in San Francisco.
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