Biowave Corp. seemed primed for its first venture-capital infusion a year ago. At the September 2002 annual summit meeting of Connecticut Venture Group, the Norwalk-based start-up had beat out 49 other companies to win the honor of “best-in-class early-stage venture company.” Its plan: develop a noninvasive device to block pain by transmitting high-frequency electronic signals into deep tissue.

But winning actual venture dollars was harder. So far, the four-year-old company has had to make do with around $2.5 million from two preferred angel-funding rounds. CEO Brad Siff admits Biowave has redesigned its business strategy, in part to appeal to VC investors; it is now marketing its tabletop device to physicians instead of physical therapists. Still, Siff’s attempts to raise venture capital in early 2003 were unsuccessful, forcing him to raise the second round among smaller angel investors.

At the top of Siff’s wish list for 2004: “a horse race where we have several term sheets to choose from.” Those offers from VC firms, he hopes, will lead to the initial VC round of $6 million to $8 million Biowave needs to move its device through government approvals to a rousing launch in the marketplace.

Biowave, of course, is far from the only candidate for venture capital to be seeking venture backers—preferably ones with that mystical blend of deep pockets, business acumen, and hands-off support of existing management that entrepreneurs dream of. In a private-equity market that experts generously describe as static, VC firms are parceling out a sparse $4 billion per quarter from what PricewaterhouseCoopers calls the “money tree.” In the process, venture firms have kept another $70 billion on the sidelines, earmarked for investment but not allocated. It is “dry powder,” in the terminology of an industry that clearly has an ear for metaphor.

“What we have seen in the last five quarters is a legitimate attempt at stability, and a dramatic stop in the decline [in investment],” says Kirk Walden, PwC’s national director of VC research. Since the 2000 peak, “investment had been falling steadily, seeking its own natural level.” Because upturns in VC investment tend to lag stock-market surges by at least a year—and require decent initial-public-offering or acquisition markets—experts are watching 2004 for signs of life in those areas.

Meanwhile, for now the quarterly investment level “is the right place for the VC industry to be,” says John Taylor, vice president of research for the National Venture Capital Association (NVCA). “One of the things keeping investment at that level is the ability of the industry to absorb and manage those [entrepreneurial] companies.” He explains, “There are only so many board seats that a venture capitalist can take on at any one time. I don’t know whether that number is six or eight or whatever, but it is very much a factor.” At the peak, money flooded into VC firms—more than $100 billion in 2000 alone—much of it for Internet start-ups, and much of it “into the hands of people who didn’t have the experience to manage well,” says Taylor. “I hope we never see that again.”

Eye for Management

Of course, that $4 billion per quarter is going somewhere. Currently, life sciences accounts for nearly a third of total investment, up from an historical level of 10 percent. (Under that heading, biotechnology grew steadily last year, while the medical-devices area held its own.) Information technology—still the largest target for venture capital—has shrunk to 60 percent of total investment, from 70 percent in the Internet’s heyday. Across all categories, though, VC firms have been looking for solid management experience at the start-ups, and some semblance of finance discipline.

Management skill is one reason that IT consultancy Form + Function Consulting Inc. broke through to its first VC infusion late in 2001. By developing a business plan tied to immediate needs, IT-marketing veteran Bob Bernard was able to convince VC firm Wheatley Partners that year to sign on for 27 percent of Form + Function, while a second VC firm, Topspin Partners, took about 20 percent. Total financing: about $8.5 million.

“We were very fortunate because of the model we were bringing to the market, and the experience of our management team,” says Bernard. By then, things were very different from the “more-opportunistic VC market” of the 1990s, when start-ups got money when they lacked management “but seemed to have a good concept.”

With a second $6 million round in 2003, Form + Function was able to acquire divine/Whittman-Hart Inc., a consulting firm whose core Bernard had founded in 1984 and run successfully for years—before an ill-timed merger led it into serious financial trouble in 2001. (The new company is called Whittmanhart.)

According to Paul Wimer, managing director of Roslyn Heights, New York based Topspin, Form + Function stood out because of Bernard’s previous ability to start and grow a substantial consulting firm. Bernard’s company offered measured ROI, and a customer guarantee, as part of its formula. “This was a space we knew well, and a person we trusted,” says Wimer, who himself worked previously at Andersen Consulting.

Because Bernard’s experience also included making the merger that had hurt his former firm, the VC firms kept a close eye on him and his CFO, Scott Knoll, until they were certain the two were on the right path. “Our initial discussion point was, ‘Do we need to have a stronger CFO on board?'” says Wimer. Monitoring was especially intense when Form + Function acquired divine/Whittman-Hart, because that deal required additional capital. To be extra careful, the VC investors have kept in contact with a former CFO of the old firm—someone who knew Bernard well. But annual revenues have grown from $1.5 million in 2001 to $25 million last year, according to Bernard. And Wimer says the company is close to breaking even, and is on course for a possible IPO or other sale in about two years.

A Mysterious Cycle

Whittmanhart is shaping up to be one of a number of successes of $213 million Topspin, which Wimer describes as a “generalist venture fund,” with 23 separate investments in several fields ranging from telecommunications to biotechnology to that current flavor of the month, homeland-security equipment. “We’re about 65 percent invested,” says Wimer, who projects that by the end of the year Topspin will be moved to raise new amounts to replenish the dry powder for the first time since its initial year of 2000—a phenomenon he expects at other venture firms as well.

Among the markets where Topspin invests, Wimer doubts that biotech will get much expansion at the firm. “It’s one of those markets where you really need expertise,” he notes. In all of the life sciences, investors must look beyond the issue of whether a particular biotech or medical-device solution eventually works—a low-percentage proposition in itself—and factor in extra risk of delays from government approvals.

At Biowave, of course, those risks are all in a year’s work. Venture capitalists who specialize in biotechnology have learned to commit themselves to a blend of seed money and additional funding that is needed to support it—generally broken down into early-stage, expansion, and later-stage divisions. And through most of last year, less than a quarter of VC investment was in the form of seed or early-stage money. But from CEO Siff’s perspective, at least, there has been a noticeable mood swing in the past year toward earlier-stage investment. “I get the sense that there’s a general loosening of the purse strings,” he observes. “There are more deals, with larger amounts of capital being put to work in health care, medical devices, and biotech in general.”

Or perhaps what he’s seeing reflects expectations of a cyclical rise in overall VC investing—one of the industry’s unexplained phenomena—that may now be starting to boost all categories. For some reason, “the business cycle for venture-capital investment runs every 10 years, no matter what,” says the NVCA’s Taylor, who notes that the last strong upturn began in 1994.

Roy Harris is senior editor at CFO.