Getting venture capital: The game is
changing, here's the new playbook
By Jenny C. McCune • Bankrate.com

The venture capital landscape is changing.

The economic equivalent of earthquakes -- rising interest rates, the threat of inflation, dot-coms turning into dot-gones, and the jittery stock market -- is shaking up how venture capitalists do business and with whom.

But small companies can still succeed in nabbing venture capital if they stay abreast of the changes.

Outlandish is out: Whatever metaphor you use -- Tim Cockshutt, a principal with Advantage Capital Partners, an $82 million venture capital fund headquartered in New Orleans, prefers "The souffle is collapsing." -- outlandishly overpriced deals are out, probably permanently.

Show me the return: Too much good money was invested with too little thought given to the return during the heyday of dot-coms. Now venture capitalists are more cautious. They're investing in companies where there's a defined return on investment -- that is, there's a projected timetable for when the company will make money.

Established companies preferred: The types of companies -- by industry as well as company stage -- that venture capitalists are investing in are changing too. Established companies are preferred. Startups and e-commerce sites have fallen from favor, the experts say.

Instead, good investment candidates are companies involved with improving the infrastructure of the Internet or telecommunications. Advantage Capital Partners continues to give established companies expansion funding and it sees more VCs taking that tack instead of funding companies that may have a bright idea but don't yet have revenue or customers. "Everybody's gotten a lot more conservative," adds David Yarnell, general partner with Brand Equity Ventures, a $200 million funded VC firm in Greenwich, Conn. "They're really hunkering down."

More realistic timetables: No more nine months to initial public offering and nearly instantaneous recoupment of investment. Although Cockshutt believes that ROI (return on investment) timetables have been permanently shortened, they will still be longer than nine months -- and more grounded in reality than in the recent past. "Back in the early 90s, it used to be five to seven years," he says. "It won't go back to being that long, but it will certainly be longer than it has been of late."

Investment money is still out there: "Talking with venture capitalists, the volatility in the market hasn't slowed down the pace of investing," says Jeanne Metzger, director of marketing for the National Venture Capital Association. Indeed, many venture capital firms have sizable war chests and they must invest that money somewhere in order to get a return, says Brand Equity's Yarnell. He believes there's something on the order of 25 venture firms with $1 billion or more in funding. Firms like Brand Equity and Advantage Capital focus on relatively small investments of under $3 million, but the larger firms may not have the luxury of making such small investments. They have a lot of money to invest and can't oversee lots and lots of little deals. "But you won't see as much funding of $50 million for an initial round," Yarnell says. "That has slowed down and nearly stopped."

Redirecting investments: "Venture capitalists seem to be investing in companies that are working to enhance Internet and communications infrastructure," NVAC's Metzger says. "They are shying away from business-to-consumer deals." They're even looking outside the Internet, which can be a boon to a company that only recently was having trouble landing funds because it wasn't Internet-based. "I suspect that dot-coms sucked up a lot of attention and money from the venture capital community," Cockshutt says. "Now venture capital firms are looking around to other types of companies to get involved in ... It might be easier for non-dot-com companies going forward."

Sitting on current investments: Not all firms are venturing outside their circle of existing investments. Many are focusing on making the companies they've already invested in successful rather than branching out into new companies. "Many venture capitalists are focusing on growing the companies they are already involved in," Metzger says.

Supply is up, but so is demand: Venture capitalists have record funds to invest, but now that Wall Street has turned a cold shoulder to dot-coms, these companies must turn to private equity -- especially venture capitalists -- to get late-stage financing. "Obviously, with the public market collapse of the dot-coms, a lot of those companies basically are getting pushed back onto the private equity market. The public market door has slammed shut, so they have to knock on private equity," Cockshutt says. So while the funds exist, if anything, more companies will be pursing them, so companies that need VC dollars must work harder than before. "It's much harder to get funding today as a startup," Yarnell says. "Frankly, a lot won't get funded." (See our tips on courting VCs).

So when you think venture capital, think reality check. While the sizable deals that were made almost against reason are gone, more realistic expectations by both investor and the company seeking investment is probably a better deal for both sides.

Jenny C. McCune is a contributing editor based in Montana
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-- Posted: Sept. 1, 2000