Investing Suddenly Got Riskier

Editor's Note

October / November 2008 By: Bob Cochnar Volume 6 Number 5

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And how will the economic convulsions affect the availability of venture capital? Since we're a bimonthly publication, anything I might offer here will most certainly have been overtaken by events. It's fair to say, however, that securing equity capital suddenly got harder.

Actually, the VC community had become considerably more conservative earlier in the year. Venture-backed company exits, for example, continued to lag in the third quarter of 2008, according to the National Venture Capital Association. Mark Heesen, the NVCA president, says that the companies "ready to exit are very strong— so they will remain in the VC portfolio until conditions improve.

"Should the current situation be prolonged into 2009, we can expect fewer new investments by the venture industry as they will need to spend their time with these later stage companies that are waiting to go public or be acquired."

VCs, however, won't stop looking at potential investments. Capital is available to the right companies, although figuring out who those "right" companies are has become more difficult.

Kleiner Perkins Caulfied & Byers, the Silicon Valley giant, has been financing startups (Google, Netscape, etc.) for more than three decades and figured prominently in a recent article in The New York Times Magazine. Kleiner partners noted that ventures usually fail because they are unable to overcome four risk factors:

"To begin with," the article states, "there is technology risk. As Ted Schlein, a Kleiner partner, says, —Can it be built? How hard is it to build it? And if you can build it, can other people build it as well?'
"Next, Schlein said, is what he and his partners call —people risk.' How good is the team pitching the idea and can its members execute their idea well? The third risk involves selling the product in the market, which most Kleiner partners believe is the hardest to gauge before making an investment. In Schlein's words, —Okay, let's say we can build it and get great people. Will anybody buy it?
"The final risk is financial. Venture capitalists who back a company in its earliest stages typically invest only a fraction of what it takes to bring a business to market; as the company grows, the rest of the financing necessary comes at later stages."

Kleiner Perkins's Four Risks should be addressed thoroughly in any entrepreneur's business plan, elevator pitch and formal presentation. Even if these marks are hit, there's no guarantee of funding, but if the marks aren't hit, you can be reasonably assured that you won't be seeing any money.

Venture capitalists still see U. S. companies as the No. 1 place in which to invest, according to a 2008 study of global trends in venture capital by Deloitte Touche Tohmatsu. The survey sought to identify where venture capitalists believe the best technologies are being developed around the world, asking specifically about telecommunications, semiconductors including electronics, software, biopharmaceuticals, medical devices and equipment and alternative energy.

So the U.S. is in the top spot in each of these areas, says Deloitte's Mark Jensen, but "the globalization of innovation is underway. The rest of the world is finding out what they're good at and venture capitalists recognize where those strengths lie."