Ugly, indeed. Returns for venture capitalists, who make their living backing and nurturing startups, have sunk to their lowest levels ever. They have been negative for three consecutive quarters, down a cumulative 25%, according to researcher Venture Economics. No rebound is in sight.
Even more ominous for venture capitalists over the long term is the anemic pace at which they are seeding new upstarts. First-time financings are down 71% from their high in 2000, to 245 companies for the third quarter of this year, according to investment tracker VentureWire. Total investments -- including second- and third-round financings -- are off 53% over the same period. All this even though VCs are sitting on some $50 billion in uninvested funds.
POSITIVES VS. NEGATIVES. What gives? Traditionally, this is the time you'd expect venture capitalists to get cracking on new ideas. Overblown prices for startups are no longer a deterrent: Valuations of companies being financed for the first time have plummeted by nearly 60% from their peak in 2000, while second- and third-round deals are down 66%, says Venture Economics.
What's more, competition among startups vying for similar markets is almost nonexistent, since so few business plans are getting off the ground. Recruiting talented employees and executives is now a snap, too. "It is the best time to make investments at bargain-basement prices," says Raphael Amit, a professor of entrepreneurship at the University of Pennsylvania's Wharton School, "but this is a severe and unique cycle in venture capital."
Turns out a whole host of factors is keeping VCs largely on the sidelines. One of the most serious -- and unpredictable -- is the slide in capital expenditures on technology. That has turned off many VCs, since few experts see much of an uptick in corporate spending until 2003.
Venture capitalists fear that if launched now, startups aiming to ship products in 18 months or so won't be able to find buyers. "Everybody is waiting for visibility as to when customers will come back," says Kenneth P. Lawler, a partner at Boston-based Battery Ventures, which halved the number of new deals it will do this year compared with 2000.
NURSING DUTY. Another factor is the necessity of funding investments over time. Without a friendly stock market, few companies will have the chance to go public anytime soon: Just five venture-backed deals completed initial public offerings in the third quarter. Mergers and acquisitions are down, too. So, for the foreseeable future, VCs need enough money to support businesses for longer periods.
In addition, many firms are stuck nursing troubled investments left over from the boom. "You can't look at new deals when you are in emergency board meetings for companies trying to raise money," says T. Bondurant French, CEO of Adam Street Partners in Chicago, a large investor in venture funds.
Of course, venture capitalists are finding -- and funding -- some promising startups. For instance, Groove Networks, an enterprise software company founded by Ray Ozzie, inventor of Lotus Notes, raised $54 million in October.
TAKING IT SLOW. Even so, the VCs are taking much longer to commit. Due diligence that would have been done in a couple of weeks a year ago now can take several months. "There's no urgency on the part of investors," says Mel Ziegler, co-founder of ZoZa.com, an online apparel site that folded in May because of a lack of funding.
The slow-mo VC approach seems to be just fine with investors such as pension funds and insurers, at least for the moment. "This year, we have a 'get out of jail free' card," says Gary E. Rieschel, managing director of Softbank Technology Ventures. "Any behavior is O.K. But next year, investors will want to see that we have confidence about where to put their money." Presuming, of course, that confidence has returned by then. By Linda Himelstein in San Mateo, Calif.