Venture Capitalists Face More Challenges Than Ever

Since 2003 I have been following the local and national venture capital market from a distance. In the early years because of the possibility of using venture capital funding to further our growth at iContact and more recently as a source of growing capital and helping other North Carolina businesses along their paths to success.

Since 2006 I have felt like venture capitalists in the Triangle area of North Carolina have been slowing down. A number of the funds that were actively pursuing technology investments 2-3 years ago seem to have gone silent. Although my impression could just as likely be from a shift in their focus from information technology to bio-technology startups as I live entirely within the web tech startup world these days.

I do know that most of these funds in North Carolina claim to have expertise in assisting both info-tech and bio-tech companies and most employ some sort of credentialed academic with a background in chemistry or biology to assist them in evaluating deals.

I read an article this evening in USA Today covering the new challenges of the venture capital industry. They mentioned the new landscape of startups that are now located all around the globe and highlighted DFJ's strategy of putting small offices everywhere to increase their local-touch coverage.

They also mentioned that the lack of venture backed IPOs in the second quarter of 2008 is further discouraging VCs and their limited partners, the people who give them money to invest.

As a few experts mention, venture capital funds are toiling with a strategy of long term growth that requires them to put more money over more time into their portfolio companies which means a few things. First, they won't be expecting to get cash back from the proceeds of the sale of their companies quite as fast as they've expected in the past and second, with more money going into their companies assuming a stagnant or falling average fund size they will be forced to invest in fewer companies overall.

This will of course result in them being even more stingy in their review of potential investment deals than before because they'll expect to live with them longer and to have fewer alternatives in their overall portfolio in case things turn south.

The number of VC firms was also mentioned, with the total since the dot-com era being nearly 1,000. It's incredible to consider the challenge that most entrepreneurs have in raising VC money considering the sheer number of opportunities available to them. Although, if you were to narrow this total number down by region and by specialty (information technology, bio-technology, clean energy technology, etc) and by the stage of company typically invested in (concept, pre-revenue, early revenue, expansion, long-term growth) I bet you would get a much more realistic picture of what we're all up against as entrepreneurs and that is a small handful of VC funds within a two hour flight that have a clue what you're talking about when you make your pitch. I'll hold judgment on who's fault that is :)

The also article took note of the emotional result of the challenges that VCs now face stating that "[n]ot surprisingly, venture capitalists are gloomy about the near future. " It mentioned a survey done by University of San Francisco entrepreneurship professor Mark Cannice among VCs in the high tech corridor in California and that "[t]heir confidence last month fell to record low of 3.0 on the 5-point scale of the Silicon Venture Capitalist Confidence Index."

With the economic uncertainly of the moment right now is a great time to get down to work building a great business behind the scenes. Looking for investment capital right now is going to be a challenge because VCs have to be very very careful where they place their bets. Build for the long term and build for the type of profitability that will allow you to fund your own growth. On the flip side, if you're a growing company that is profitable or that has profitability in sight now may be the perfect time to raise venture capital under great terms.

Firms that are traditionally more early stage investors are looking now to make investments in slightly more established companies that offer them a higher chance of survival at the cost of missing out on some tiny diamonds in the rough that might have provided them a 10X or greater return over the mid-term. As a growing, cash-flowing company focus on proving the predictability of your revenue streams and don't lose sight of the fact that VCs need your growth in their portfolio.

But also keep a version of your plan hidden in your top desk drawer that gets you through to IPO without any additional outside equity investments. If the VC market crams down any further in the next few years hunker down may be the name of the game for a while.