As chair of the business department at the law firm of Barnes & Thornburg, David Millard has spent decades helping high-growth companies secure venture capital. In this economy, it's much tougher for even promising small companies to attract interest from VCs. The key for entrepreneurs is to get to know investors early on and stay in touch with them before they need to raise capital, Millard says. The Indianapolis-based attorney spoke recently to Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow.
Karen E. Klein: A new private markets study done by Pepperdine University shows that venture capital firms have pulled back on new investments and are instead putting more money into companies that are already in their portfolios. Is that what you're seeing?
David Millard: I am. Most VC firms are keeping their powder dry and doing tons of insider rounds. By and large, these aren't down rounds; they're typically at about the same price as the prior funding rounds. They are much more reticent and hesitant to make investments in new companies.
Is economic uncertainty fueling that trend?
I'd say there are three things: less support from their limited partners; less money coming into the venture firms; and portfolio companies needing additional capital and not being able to get it elsewhere.
Why the drop in support from the VCs' limited partners?
The limited partners—the family offices, pension funds, and foundations that fund the venture capital firms—have found themselves over-allocated in the area of alternative investments, like venture capital. When the stock market drops, the 15 percent they committed to alternative investments might suddenly be 30 percent of their total. And somebody on their board says: "Wait a minute, we can't have 30 percent in alternatives or somebody's going to skin us alive."
The limited partners are not screaming "Stop" like they were during the last quarter of 2008 or the first quarter of 2009. But the uncertain environment continues out there. And that's a big reason that venture firms' own fundraising is down and they are reducing their levels, in terms of new investments.
You're optimistic that venture capitalists will begin jumping back into the market soon. Why?
We have been seeing more activity picking up across the board. It's better than it was in 2009 and things are steadily increasing. The thing is, the curve isn't tilted up very high, so it's hard to feel the effect. In fact, I'd say there's more activity going on with the angel investors than with the VCs.
Right now, there are opportunities to invest in phenomenal companies with good valuations, rich terms, and very little competition. There are opportunistic, smart VCs who realize that now is the best time to be investing and we're doing deals where these people are going to make a lot of money.
What's the outlook for entrepreneurs that in the past would have had a good shot at getting venture capital investment?
In the last year, the valuations that the VCs are putting on companies aren't too bad. The pain now is in the funding terms because it's hard to even get interest. Typically on a VC deal in the past, if you had a decent company, you'd have two or three term sheets [venture capital funding offers]. If you had a great company, you'd have half-a-dozen term sheets. In today's world, you're happy to have one. So if you really need the money, you've obviously got very little leverage and the terms are much richer now for the VCs.
What advice are you giving your clients?
Make contacts with venture capital firms early on—I'm talking a year or 18 months before you're going to them for money. They like that because they can look at a business plan and then look at the company's financials in 12 months and see if the company has delivered or over-delivered, in which case they'll be much more interested.
So make sure you've got the right kind of VC, one that specifically invests in your kind of company. Then get a warm introduction and let them hear from you every six months or so, while you're doing angel rounds. Don't bug them when you're just coming out of the garage, but do touch base earlier than you might have in the past.