Growth Strategies

Looking for Funding? There Must Be Something Wrong With You

Venture capitalists are still reluctant to invest and will look skeptically at any company willing to sell itself during this down market.
Sarah JohnsonApril 30, 2009

Mark Rostick didn’t mince words to describe the current state of venture capitalists’ willingness to take risks on young companies these days. “No one has any money to buy anything right now. Nothing,” said the director of Intel Capital during this week’s annual meeting of the National Venture Capital Association in Boston.

Like most companies, Rostick added, Intel is in penny-pinching mode and will only pay attention to entrepreneurs that could offer the chipmaker immediate cost savings or revenue growth. He discouraged companies hoping to get VC funding from wasting their time by offering investors like him only long-term returns. Instead, suggested the VCs at the conference, who invest on behalf of corporate-sponsored venture-capital funds, companies thinking of selling to VCs should spend this downtime networking, forging relationships with potential buyers, and hoping to ride out the crisis for up to two years.

Indeed, venture capitalists are reluctant to open their wallets, and deal-making overall has been dormant. Dan Williams, managing director at investment bank Montgomery & Co., characterized overall deal activity as being at a 10-year low with transactions taking longer and more deals falling apart.

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For the first quarter of this year, VCs invested only $3 billion in 549 deals. They invested more than double that amount during each of the first three quarters of 2008. Moreover, last year, just six venture-backed companies went public, the lowest level since 1977.

Still, professionals in the VC industry tried to sound optimistic this week, even after NVCA announced that VC funds lost 20.9 percent of their value last year. Williams believes the market is stabilizing as more buyers appear to be putting their “toes in the water” to see what’s out there. Nonetheless, he predicts a slow recovery.

To be sure, like house hunters or Hummer collectors, investors willing to buy small startup companies have the upper hand. There’s a bargain bin out there, and most sellers are desperate for financing. “If you don’t need to sell today, you probably won’t [be trying to sell], and if you are selling, you’re probably in some sort of distressed state,” said Rich Miner, managing partner for Google Ventures.

Indeed, Brent Brown, managing partner for Madison Parker Capital, estimates 80 percent of companies looking for venture backing are in distress, have balance sheet issues, or are in a workout situation. Only companies that can offer double-digit revenue growth, increases in EBIDTA, and good management are getting “decent” valuations, he added.

The VCs said buyers are more aggressive and are pushing for lower prices and tight covenants. They’re focused on investments that are cheap and risk-free because “growth is at a premium,” Rostick said.

And corporate VCs like Rostick have little leeway for investing as their company’s senior management and board of directors are reticent to spend any cash. “It’s a good time to go looking, but whether we do [any acquisitions this year] or not remains to be seen,” said Rostick.

Still, Lorena Scott, director of corporate development at Turner Broadcasting, predicts her parent company, Time Warner, with $9 billion in cash, will make some buys in 2009 even though it’s historically not been acquisitive. She said her division has a short list of five companies it would like to go after this year.