Signs of life in the venture capital market

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Five years after the painful burst of the dot-com bubble, the venture capital industry is finally getting back on track. But don’t expect a return to anything close to the frenzy that gripped the markets at the turn of the millennium. Though there’s still more money available than venture capitalists can invest, garage entrepreneurs looking for funding face a tougher search for cash than they have in at least a decade.

In the years following the dot-com bust, most venture capitalist firms focused on keeping struggling companies alive as the market for initial public offerings all but evaporated. That left many firms with the painful choice of either continuing to pump money into a start-up for longer than they had planned -– or pulling the plug and walking away from their investment.

“All of us were engaged in portfolio repair work, basically, said Walter G. Kortschak a partner Summit Partners in Palo Alto, Calif.

Now, after a three-year slide from the peak of the dot-com boom, venture capital funding appears to have hit bottom in 2004, as overall investment in new companies began slowly picking up, according to figures released Monday by the MoneyTree Survey, a widely-watched quarterly report on venture capital spending. The total number of deals also picked up slightly last year after a four-year decline, the survey found.

Some $20.9 billion was invested in 2,876 deals in 2004, the first increase in three years, according to the survey.  That compares with $105.9 billion invested in 8,074 deals in at the height of the dot-com boom in 2000.

As the industry has stabilized, venture capitalists have become choosier than ever about which companies get funded, according to said Bill Stensrud, a managing director at Enterprise Partners in La Jolla, Calif.

“The number of (business) plans still vastly, vastly outweighs the amount of money that’s being invested in those plans,” he said on a conference call discussing the survey results. “The bar is much higher than it has ever been in my career.”

A start-up company trying commercialize a new technology has to have a product that is “truly disruptive” before his firm will consider backing it, said Stensrud.

Still, there are plenty of investors looking to get in on the ground floor of a new company before it puts together its initial public offering, according to John Taylor, Vice President of the National Venture Capital Association, one of the survey’s co-sponsors.

“There is a huge amount of money that wants to invest in this asset class,” he said. “A lot of these (venture capital) funds are going out to the marketplace to raise money and they’re turning down 50 percent of it or 70 percent of it.”

The list of industries drawing the biggest share of venture capital hasn’t changed much since the IPO frenzy of the late 1990’s.  Software companies topped the list in 2004, drawing $5.1 billion in new investments.  Some $3.8 billion in venture capital went to biotechnology companies. Medical devices and equipment ($1.8 billion) computers chips ($1.6 billion), networking hardware ($1.6 billion) and telecom companies ($1.9 billion) were also popular with venture capital investors.

While garage entrepreneurs continue to cook up novel computer technology, some of the hottest ideas are geared toward consumer products, according to Stensrud.

“In 2004, for the first time, the total dollar value of semiconductors embedded in consumer products exceeded the total dollar value of semiconductors embedded in enterprise and industrial products,” he said. “So we believe that a lot of the focus of technology for the next 10 years will be in the in the consumer space as opposed to the enterprise space, and we are moving our focus accordingly.”

There’s also been an increase in the amount of money invested in later stages of a new company’s development, according to the survey.  With stability returning the market, venture capital firms have become more patient, and start-up companies are taking longer to go public.

As the IPO market has recovered, it is also seeing a pickup in the number of offerings from an entirely different breed of company, according to David Menlow, president of IPO Financial Network. So-called “private equity” firms have been taking mature, industrial companies private, restructuring them financially and them taking them public again, he said.

“The problem is that although the financial mechanics of it make sense for the private equity firm, they’re really taking the companies and turning them upside down loading them up with debt,” said Menlow.

“It’s a financial transition only for these private equity firms,” he said. “And investors are going to say they’re tired of putting their money in someone else’s pocket. They want the money to go to the company and have them benefit from it directly -- rather than raise $300 million and have it go to the private equity firms as a special dividend.”