Shaking the Money Tree 05/31/00

There’s More Money In The Game, But Investors Play Cards Closer To The Vest

John Burke Looks Tough

Investors are doing more thorough due diligence these days because the investments are bigger, the schedules are longer and the risks are greater. Yet, the risk in choosing the wrong partner is far greater for the entrepreneur than the investor, so do your due diligence at least as thoroughly as they do. John Burke of ABS Ventures advises:

1. Look at the deals they’ve done. Are they similar in stage, size, industry? Talk to the companies in which they’ve made investments, and not just to the rosy ones. Talk to the investments that did not work out and see how the investor reacted.

2. Look at the partners. What kind of backgrounds do they have? Have they been VCs their whole lives? Have they ever actually a created a product or built a business?

3. Look at the portfolio. Are there synergies? Can they make helpful introductions? Can you kiretsu?

4. Look at the level of involvement you want. Do you want them to sit on your board, or do you just want their money. Maybe it’s their Rolodex you want. Some investors are more active than others, so make sure your philosophies match.

5. Look for the next step. There are tiers within the industry. Where can this investor help you go once you’ve graduated from the early stages?

(Reston, VA -- August 31, 2000)
Despite recent stock marketfluctuations that have left almost everyone dizzy, venture capital investments in Washington, DC area companies hit a major milestone in Q2/2000, surpassing $1 billion dollars in a single quarter for the first time, according to the latest results from PriceWaterhouseCoopers’ (PwC) latest MoneyTree™ survey.

“It's expected that venture capital investment is going to remain strong,” said PwC’s Kevin Thompson, discussing the numbers at “Shaking The MoneyTree,” a quarterly event hosted by PwC and the Morino Institute’s Netpreneur.org, “There is plenty of money in the venture capital funds.”

That’s the good news, but it doesn’t mean that entrepreneurs can expect to sit back and be wooed any longer. There may be more money available for the right deals, but the Internet gold rush is largely over and netpreneurs will have to work harder to get it. What’s more, many questions remain, according to Thompson, such as, “What will happen if the public markets remain difficult? What's going to happen to valuations? What's going to happen to very early stage deals?”

A panel of venture experts at this morning’s event offered answers to these and similar questions, examined the implications of VC activity for Greater Washington’s Internet entrepreneurs and offered practical advice for netpreneurs seeking money amid the mixed signals. PwC provided the data from it’s most recent MoneyTree survey, and the insights were provided by John Burke of ABS Ventures, John May of New Vantage Partners and John Muleta of PSINet Ventures.

In Q2/2000, venture-backed investments in Greater Washington companies hit a record $1.147 billion, exceeding the previous record of $853.3 million set last quarter and more than triple the $329.7 million recorded in Q2/99. Of the money collected by regional firms, $785 million or 68% went to Internet-related companies, and the breakdowns by sector show how assessing what’s “hot” is still a moving target. Access & Infrastructure, Tools & Applications and Services remained the region’s strengths, garnering the most Q2 money. Both B2B and B2C eCommerce, at one time each the darling of investors, still saw a large percentage growth in the region, but those numbers might be slightly misleading for several reasons: they reflect deals already in the pipeline during Q1; regional investments in those sectors were comparatively low during the previous quarter, leaving plenty of room for growth; and the size of rounds in those sectors tends to be much smaller than the mega-deals seen in the other spaces.

Nationally, eCommerce deals were down from Q1, but netpreneurs in the commerce and content sectors can take heart from Muleta’s observation that if a lot of money is going to telecoms and Internet infrastructure companies, “That tells me it is a matter of time before the B2B's and B2C's come back. It's all cyclical. You have to have a business plan or an idea that can last until the next wave comes in, but what do you think they are going to do with all this infrastructure?”

Comparing Internet Sector Deals (in $ millions)
	DC/Q2	DC/Q1	%+/-	Nat’l Q2	Nat’l Q1	%+/-
Access & Infrastructure	$196	$245	-20%	$1,870	$1,690	+11%
Services	$194	$127	+53%	$2,990	$2,410	+24%
Tools/Applications	$185	$61	+203%	$2,850	$2,210	+35%
B2B eCommerce	$118	$20	+490%	$1,580	$1,890	-16%
B2C eCommerce	$54	$23	+135%	$1,360	$1,470	-7%
Content Sites	$38	$52	-27%	$1,010	$1,280	-21%

One trend that accounts for some of the growth in both national and regional venture numbers is that more companies are going for more and larger later rounds as an alternative to IPOs in today’s tricky markets. “We expect to see that trend continue,” said Thompson, “because you get almost as much money right now through a large private round as you could in an IPO.”

The private markets have changed in response to public market conditions, leading Thompson to ask whether the search for venture money has become a buyer’s rather than a seller’s market. Yes, to a large degree, agreed the panel, noting that VCs have become more selective and valuations have continued to go down. Being in today’s hot sector and a having a proven management team may produce exceptions to the trend, but, as a general rule, Muleta observed, “It's a tough market, so you have to be well funded. Money is going to be difficult to come by, so show a plan for 18-24 months. The VCs also have to support other companies they have already put money into, so there is more claim on dollars from the hot times. Investors have to support companies for three or four more rounds than they originally thought, because they thought they were going to take them public a lot faster.”

Burke added, “One reason why deal size and round size have gone up, but the valuations have not gone up measurably, is probably because most groups are now funding for 18 months of cash. If you’re business model is predicated upon free, easy access to money, you're going to have a hard time. People are raising more money to put away to weather the storm.”

And while some sectors may be hotter and more competitive than others, don’t think that a little cutting and pasting in the business plan can help you jump from one to another. Entrepreneurs have tried, but, according to Burke, “It’s so weak when somebody comes in with a B2C model and three months later they’re back and now it’s B2B2C and they’re saying ‘It's changed! It's better!’ No, it's very weak and it’s transparent. The deeper issue is that if you have to change the model to get money, you have a real problem. You're not passionate about what you're doing; it's not really what you love; you're just chasing the dollar. It's just financial engineering, and it's clear to the investors.”

In the end, interest may flutter between sectors and public markets may fluctuate between highs and lows, but the fact remains that there is more money available and being invested than ever before, and a lot of it is making its way to this region. “The world is awash with money,” observed May, “so it's judgment and time that we're really dealing with.”

A good bit of that money is coming from a new group of increasingly active players, corporate venture funds like Muleta’s PSINet Ventures. According to May. “One of best things going on in our region is the proliferation of funding sources that are non traditional¾sources outside the region, corporate sources, angels, accelerators, you name it. You don't have to just think ‘either/or.’ Almost all the groups syndicate, almost all are getting to know each other and figure out who the quality players are. One of the things to learn about is the new lay of the land of multiple funding source and how to use them.”

Working with a strategic corporate investor can have advantages and disadvantages. On the upside . . . well . . . it’s money, first of all. Corporate investors also can bring technological and marketing partnerships sometimes, and many such funds, like PSINet Ventures, offer services including hosting or Internet access in return for equity instead of cash. This can help stretch your dollars in a time when high cash burn rates are no longer attractive. On the downside, remember that big corporations rarely move as quickly as startups, so be sure that those proposed technology and other partnerships will be more real than imagined, and remember that these corporations will very often have strategic goals different from your own. Money always comes with strings attached.

If the good news is that there’s more money available from more sources, the challenge is that you’ll have to work harder to get it. Particularly, it puts an even greater onus on entrepreneurs to become more diligent in their due diligence when it comes to picking investors. Muleta offers advice for sizing up corporate funds that applies equally well to VCs, angels or any other source of funding: “Listen to them first. Understand their strategic initiatives. If it's not a fit, walk.”