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I’m OK, You’re OK, But We’re Not Investing
VCs Discuss Getting Early Stage Funding After The Bubble

(Washington, DC -- March 22, 2001) It’s become conventional wisdom by now that investors are tightening their wallets and riding out the market downturn now that the “bubble” has burst.  Everyone says that it’s harder to get deals done and, when they do, valuations are way down.

Why is it, then, that when a panel of four investors were asked this morning whether they’ve seen a decrease in deal flow, two said yes, but two others said no?

Just what is really going on in the early stage funding market, anyway?

That question was the heart of the matter at this morning’s Netpreneur Coffee & DoughNets meeting where four leaders in the early-stage space¾Laura Lukaczyk of Avansis Ventures, Zim Putney of NextGen Capital, Joan Winston of Steve Walker & Associates and Jeff Weiss of ASAP Ventures¾discussed today’s investing climate and what it means for entrepreneurs seeking funding.  Billed as “I’m OK, You’re OK, But We’re Not Investing,” the speakers explained some of the current “post-bubble” pressures on investors in order to help entrepreneurs adapt.  As Netpreneur’s Executive Director Mary MacPherson explained in her introduction, the idea came from a recent meeting with investors.  “One of the things that came through loud and clear,” she said, “was their sense that the entrepreneurs knew intellectually that things had changed, but they seemed to be doing the same things they were doing a year ago, yet getting different results¾no money.”

Back To The Future

Why did the panel split 50/50 in their assessment of deal flow?  One reason is because certain markets are still very hot, such as optical components, data communications equipment and storage equipment, three areas where Avansis’ Lukaczyk keeps a very tight focus.  Other segments, especially in the dot.com arenas, are less so, and one reason why many VCs are doing less investing is that their pipelines are stocked with current portfolio companies, and they have little time to take on new commitments.

Both pipelines and market space can give two significant cues to entrepreneurs.  For the former, a rejection may not necessarily reflect on the quality of your venture, it’s just that VCs will have to be more selective for a while as they tend and prune their portfolios, and they’ll be much more thorough in assessing any new deals.  As to the latter, although investors have always tended to work in markets they know and understand, many of them strayed during the last three or four years.  Part of a general “back-to-basics” movement in the industry is that investors are going back to the markets they know well.  “Space matters,” as Winston puts it, and entrepreneurs will have to go back to doing extensive homework about investors to find the ones who know enough to invest in their businesses.”

Yet the main reason why investments are down, and, yes, they are down overall, is that investors are no longer making some of the more questionable deals that were being done during the dot.com heydays.

A year ago,” said Putney, “We were force feeding the entrepreneurial system.  We, the capital community, were forcing a lot of money into a system that really couldn't adequately and efficiently use all that money.”  As a result, a lot of companies, both public and private, have since fallen by the wayside because they lacked sustainable business models. 

Weiss remembered a satiric article he saw in the New York Times a year or so ago in which the author parodied some of the more outre “principles” of Internet mania, suggesting a business plan for a company that would sell $100 bills for $95.  After initial success, cracked Weiss, “He would raise his prices to $97 for a $100 bill.  All his financial metrics would look so much more improved that Wall Street would take him public and the rest would be history.”

Less ironically, Putney agreed, “Investors were funding a lot of ideas that were not good, as demonstrated in the marketplace.  Now we're back to looking very carefully at deals, working with companies we've invested in to make sure they're successful.”  And there’s at least some bright side according to Winston.  “A lot of the “me too” ideas that were trying to get big fast and get sold back during the craze are going away.  The noise to signal ratio is getting better.  Maybe people are registering for spring semester instead of starting a dot.com.”

How Can Entrepreneurs Respond?

With investors returning to business basics, entrepreneurs will have to respond in kind.  According to Putney, “There is still money out there, but people are going to look a lot more carefully at your idea than they would a year ago to make sure that it has uniqueness, that you’ve got the right team and that you're going to have market potential long-term to make the venture successful.”

That means such things as focusing on revenues, re-evaluating businesses models and, according to Lukaczyk, many entrepreneurs will have to do a much better job of understanding and explaining their market dynamics.  She said that many don’t drill down deeply enough into customer needs and competitive dynamics she said, “One of the things that I'm going to eventually want to do is talk to your customers, or your potential customers.”  If an investor can’t do that, or can’t get consistent, meaningful answers, the entrepreneur is not likely to get funding.

More than ever before, entrepreneurs will have to prove their case under scrutiny from all sides¾financials, markets, management team and more.  “The best opportunities now,” said Weiss, “will be in building real businesses that customers love, offering sustainable advantage from disruptive changes in the market.”

The idea of disruptive technology is central for Weiss, and the other panelists as well, because investors are looking for the big return.  “Venture firms,” he said, “have traditionally invested in disruptive change.  Just having something that is incremental is not good enough.  There certainly were many companies and investments in the momentum market of last year which were just incremental, but they were features, they weren't companies.”

That’s a central part of the case entrepreneurs will have to make in order to get funding now.  First, that they understand their market, including pain areas and opportunities; second, that they have a realistic business model for satisfying it; and, third, that the potential is significant enough to interest an investor.  This need for an attractive value proposition is part of what’s driving another market factor, one that entrepreneurs are simply going to have to get used to¾much lower valuations.

“As an entrepreneur,” said Winston, “you're selling your risk.”  And according to Weiss, “venture money has gotten much more expensive.  For a brief window of time, it was somewhat less expensive, now it's very expensive.  The alternatives are customers, partners, channels and other forms of funding.  They are critical, and they have to be part of the plan.”

While customers, partners and channels are necessary for all successful businesses, VC money actually may not be, and every entrepreneur should carefully answer a question posed by panel moderator Esther Smith of Qorvis Communications: “Do I have a venture-style company or do I have a good business?  A lot of really wonderful businesses fall into the ‘good business’ category.”

Lukaczyk agreed, “There are a lot of businesses I've been seeing out there that could probably be bootstrapped with friends and family and have a nice $10 million or $20 million revenue stream.”

If you’re going for the big score, however, and think that it will take equity investments to get there, consider the panel’s advice, captured in the event transcript, and be prepared to hear more than once, “I’m OK, you’re OK, but we’re not investing.”

Copyright © 2002 Morino Institute. All rights reserved.

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