|
Until last month, the venture-capital game was almost too easy. VCs were shoving wads of cash at entrepreneurs and taking the companies public
barely a year later, raking in huge multiples of their original investments. Entrepreneurs got ever higher valuations for stakes in their ever more
embryonic companies.
Then the Nasdaq started its downward spiral. The tech-heavy composite index is down more than 30% since its Mar. 13 peak. The initial public
offering window has slammed shut -- witness the 27 withdrawn IPOs from Apr. 1 to May 12, compared with 42 for all of 1999. Almost overnight, stock
market investors' enthusiasm for public companies with no profits has evaporated. That means the IPO market is no longer a surefire exit strategy
for VCs, and entrepreneurs are noticing a distinct change in their attitudes toward investing.
VCs are using the market's plunge as an excuse to beat up entrepreneurs on valuation. Entrepreneurs have to talk to twice as many people and may
still end up with half the money they were looking for. What's worse, VCs have all but abandoned certain sectors like e-commerce, although they
have wholeheartedly embraced others like Internet infrastructure. Furthermore, interest rates are rising sharply, leaving fewer palatable
alternatives open to startups. The upshot: The balance of power is shifting away from entrepreneurs and back to VCs when it comes to negotiating
new financing.
WORKING FOR FUNDS. That doesn't mean new investment isn't available -- it's just harder to come by. "Raising financing has gone from shooting fish
in a barrel to having to do some work," says Scott Eisenberg, president of One Big CD, a Sterling (Va.) company that calls itself an Internet
jukebox. Its software allows users to keep their music collection online, a la MP3.com's, and get rid of those pesky CDs. One Big CD is
syndicating its content to Web sites like Yahoo! that already have a brand. In the Internet lingo, it's a B2B2C play (business to business to
consumer). Eisenberg raised his first round of financing with Draper Atlantic, the Reston (Va.) affiliate of Draper, Fisher, Jurvetson, back in
December when the Nasdaq was going nowhere but up.
Currently in the middle of his second of round of financing, Eisenberg has found that he must prospect twice as many VCs as he did the last time
around -- that is, unless he's willing to accept a significantly lower valuation than he would like.
Eisenberg acknowledges that financial constraints have forced him to change his development plans. Initially the company was focused on drawing in
users with free services, assuming it would eventually be able to develop the e-commerce applications that would turn a profit from its users. That
model works if the capital markets are there to fund the lag time between the first and second phases of development. When the capital market dries
up, he notes, "you have to rethink your plans." Because he'll need six months to raise his next round instead of the three he had planned for,
Eisenberg has had to hold back on building his customer base and concentrate on making the existing one profitable.
FLUSH VCs. What's odd about Eisenberg's story is that investors are still chucking cash with both fists at VCs. VC funding reached an all-time high
of $17.2 billion in the first quarter of this year, over four times the level in the first quarter of 1999. It's not that investors are nuts --
it's just that most of the ones who traditionally invest in VC funds have always had a 5-to-10-year investment horizon. Time makes the wiggles of
the Nasdaq irrelevant, whether they're up or down. "When dot-coms were getting two to three times their value on IPOs, we said, 'those returns
won't last forever,'" says Kent Grether, manager of pension investments for PacifiCorp. Grether invests $20 million to $30 million a year in
venture-capital funds.
So who's getting all these goodies? Companies that are building the Internet's infrastructure, the technology that creates connections and the
ability to do transactions in real time over the Web. Take for example, iKimbo, a Reston (Va.) company that makes the software to enable
group-to-group communication over the Internet. Chairman and CEO Jamey Harvey set out to raise second-round financing of $5 million in February.
Last week he closed a $6.375 million financing deal led by Cross Atlantic, which is based in Radnor, Pa. Within the next 60 days, Harvey expects to
bring the total up to $10 million.
Harvey found that VCs couldn't get enough of infrastructure software -- which is iKimbo's space -- as well as wireless infrastructure and pure B2B
technology plays. "We spoke to VCs who said their entire portfolios were changing as a result of the markets," says Harvey. "That was good news for
us because we're the safe harbor they all wanted to run to -- infrastructure."
"FLINCHING REACTION." Even with its infrastructure angle, not everyone was receptive to iKimbo's story. "We talked to one corporate strategic
partner whose own stock had been hammered by the Nasdaq," recalls Harvey. "They had a stronger flinching reaction than other investors we talked
to."
These days, corporate investors are either sitting on the sidelines or asking for rock-bottom valuations, which often amounts to the same thing.
"They're not VCs -- they don't have to spend their money," says Charlie Fink, president of eAgents.com, a B2C company that delivers personalized
news via e-mail.
Only six months ago, corporate investors were considered easy pickings for entrepreneurs. Now that they're a bit gun shy, VCs are pressing their
advantage in their negotiations with entrepreneurs. The poor IPO market "has made us harsher on terms," says Sprague. "We're tougher about what the
entrepreneurs have to deliver and control issues like governance and hiring and firing. We're definitely tougher about valuations."
BUYERS' MARKET. For VCs, it's a welcome change from the sellers' market that was in full swing two months ago. "We received over 1,200 business
plans in the last two months, and we passed on all of them because of the valuations," says Scott Rechler, CEO and president of Frontline Capital
Group, a publicly traded VC company.
So, is it hopeless for entrepreneurs? Hardly. There's more appetite than ever for companies that present strong management teams, well-developed
business models, and predictable cash flow. It's just that you're going to have to work for it. Says Keith Wardell, president of electronic catalog
service provider Shop2u.com, "Gone are the days of 'Here's $40 million to create a brand in six months.'" That sounds no worse than a return to
what used to be considered "normal."
By
Margaret Popper
in New York
| 
