KUHN CAPITAL Tuesday, March 20, 2018
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Studies Detail Long Road Ahead for Startup Survivors

Separate studies, by the market research firm VentureOne and the consulting firm PricewaterhouseCoopers, portray an industry still working through the excesses of the late 20th century. Sure, valuations have come down to earth, innovative ideas are percolating again and venture investment is picking up, but the cycle has a few last turns left before it is spent.

There is some encouraging news: a surprising number of start-ups survived the punishing market conditions of the last year. However, many of them will need fresh infusions of capital soon, testing the resolve of their skittish venture investors.

The VentureOne study provides perhaps the best snapshot to date of the investment frenzy inspired by the dot-coms. The research firm identified 7,235 companies at the beginning of 2001 that had previously raised some venture capital. Most were high-technology related and had raised only their seed or first rounds of financing.

Of the 7,235, roughly 11 percent have gone out of business. A small portion (6 percent) were either acquired or went public, but the great majority, 83 percent, are still alive, albeit with varying levels of vigor. Twenty-eight percent even managed to obtain financing in the difficult market conditions of 2001.

The PricewaterhouseCoopers study, which looked at a smaller sample of companies, also concluded that more start-ups than had been expected made it through the bust, thanks to a return to more conservative business basics.

Behind the rosy numbers, though, lies a harsh reality. A large portion of the start-ups tracked by VentureOne about 3,400 companies last raised money before conditions severely deteriorated in early 2001, suggesting that they will be back in the market for financing soon. Yet venture capital firms continue to be extremely picky when it comes to doling out the piles of cash they are sitting on: at last count, at least $40 billion or $50 billion in United States venture capital has been raised but not yet invested.

What's more, a high portion of the start-ups are considered early stage (read risky) and are in areas like consumer and business services that are not attracting much investment these days. "It's pretty clear that all of those 3,400 companies won't get financed," said Dave Witherow, the chief executive of VentureOne, based in San Francisco.

Venture investments have been sliding steadily, to 610 deals worth $6 billion in the fourth quarter of 2001, where they seem to have stabilized, from 1,711 worth $27 billion in the first quarter of 2000. At the same time, the interval between financings has stretched.

As the whims of the market change, so do a start-up's chances of being financed. Categories that were hot in 2000 e-tailing, online information and technology consulting, for example are about as enticing to venture capitalists today as WorldCom (news/quote) bonds are. In contrast, biotechnology considered dead just a few years ago is one of the hottest areas, along with semiconductors, communications and software.

Taking a slightly different tack, the PricewaterhouseCoopers study interviewed 350 venture-based start-ups in the United States and abroad, trying to analyze the strategies and characteristics common to successful start-ups.

Not surprisingly, the study found differences in the approaches taken by start-ups before the Internet bubble and during the bubble, which the study dated as beginning in the fourth quarter of 1999 and extending through the second quarter of 2000. During that frenetic period, companies attracted strong management teams when they were little more than ideas but typically had little to show in the way of customers or solid business models by the time they received their first round of venture financing. They were able to raise large amounts of money as investors bestowed lofty valuations on their budding companies. Those valuations were typically lowered in subsequent financing.

In contrast, companies that were started before the bubble developed more slowly but had more customers by the initial round of financing and increased steadily in value.

One factor that distinguished successful start-ups from the less successful ones was a narrow and manageable definition of the markets they were going after. "Companies that said they were going to conquer the world were likely to fail for lack of focus," said Michael Katz, managing director and chief operating officer at PricewaterhouseCoopers's global technology center in Menlo Park, Calif.

Venture capitalists have taken much of the blame for fueling the Internet bubble by backing so many ill-conceived ideas at inflated prices and then, when the market for initial public stock offerings slammed shut, ruthlessly pulling the plug on their hopeful entrepreneurs. But the PricewaterhouseCoopers study found that venture investors played an instrumental role in developing successful companies and brought valuable assistance to start-ups beyond financing. The start-ups interviewed said that venture investors were particularly helpful in recruiting, developing strategy and making introductions to potential partners and customers.

And there's the rub. The best venture capitalists have always provided a lot of hands-on guidance to their fledgling charges, and that has been a main source of their appeal. But during the bubble, so much money was thrown at so many companies investments in 1999 and 2000 accounted for 70 percent of all venture capital invested in the last two decades that even after winnowing their portfolios over the last year, many general partners are stretched thin across too many companies. The slack is picked up by less experienced junior partners, or not at all. With dim hopes of a quick initial public offering or acquisition these days, venture capitalists are facing the prospect of supporting their portfolio companies through several rounds of financing.

That math concerns many in the industry. Arthur J. Marks, a longtime venture capitalist, put together a study of his own, concluding that the flood of money into the venture business the last few years had created an imbalance of capital and the capacity of venture capitalists to manage it. The study noted that the amount of money invested by each experienced general partner had increased more than tenfold the last 10 years. "A lot of firms are trying to come to grips with this," said Mr. Marks, who was a general partner for 18 years at New Enterprise Associates before starting Valhalla Partners, his own venture firm, in Tysons Corner, Va., earlier this year.

One response has been to shrink the size of megafunds. Kleiner Perkins Caufield & Byers, the prominent Silicon Valley venture firm, told its limited partner investors it probably would not need all of the capital they had committed for a $650 million fund.

Venture capitalists may be cheered by other findings in the Pricewaterhouse study. Over all, the companies surveyed seemed satisfied with their venture investors, with 84 percent saying they would use them again.

That is, if they ever get the chance.


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