In today’s weakened economy – driven downward by the credit crisis, decreasing demand and the plunging stock market – the outlook for companies seeking venture capital investments might appear gloomy. But the reality is that local venture capitalists remain optimistic about funding opportunities.
The pace of investing in the first half of 2008 denotes that venture investing is on target to reach the $30 billion level this year, putting it on track with 2007 when $30.7 billion was invested, according to the National Venture Capital Association (NVCA). Even more so in New England, with its diverse stable of technology-based growth companies, strong companies with strong management and a well thought-out business plan in healthy sectors are continuing to get funded with good valuations.
Areas such as medical devices, consumer-related Internet, software as a service, biotechnology, clean tech, video gaming and mobile communications remain particularly attractive for local venture investors. Other sectors, such as enterprise software and security software, appear to be facing more challenging times. Also, given that the window for initial public offerings, one of the two main exit strategies that create liquidity for venture investors, remains sealed tight, even those companies in the strong industries mentioned above will face a more difficult time closing venture deals.
In any case, the changing economic landscape is impacting the post-investment realities of venture-funded companies, and therefore understanding these changes will help companies looking for funding remain attractive.
••Manage the cash burn
Whether it is increasing prices of products caused by the skyrocketing cost of oil (although oil prices are down over the last few weeks, the long term trend is one of increasing prices), decreasing revenues caused by a slowing economy, or the continued carnage in certain segments of the credit markets, the “cash is king” mantra continues to be heard. In addition, many venture capitalists (VCs) are recognizing that the second or third round of funding and/or liquidity event may now take longer than they otherwise might be in a stronger economy, requiring companies to use their cash more judiciously.
A common theme espoused by many VCs is “manage the cash burn.” Companies need to keep costs under control and wring every possible efficiency from their business models.
In the end, cash needs to last longer. Watch your spending and VCs will see you as a more attractive investment candidate.
••Be realistic with your cash needs
As a corollary to managing the cash burn, companies need to be realistic as to their cash needs in their business plans in light of the weakening economy. Many emerging companies continue to be far too aggressive with their revenue projections and have a business plan that describes a quick, albeit unrealistic, ramp-up time (or may, in some cases, call for bank loans to fund some of their growth).
Similarly, many companies tend to underestimate their cash needs, as they have not adjusted their cost and revenue projections to a changing economy. VCs are not turned off by a request for $10 million if the numbers support it; they will, however, take issue with a stated need for $5 million when clearly $10 million is needed. The lesser request may signify either a weak understanding of your industry or of the realities of running an emerging business in today’s economy.
••Understand the exit
IPOs have not been a viable option for VCs for a number of years. Given the slowing economy and unsettled financial markets, this situation is not expected to change anytime soon. Many VCs consider the sale of the company to a larger company to be the only viable exit strategy. While the time to exit may be somewhat longer in certain cases, particularly in later-stage investments, companies must understand and build into their business plans a realistic M&A event as a path to liquidity for the VC investors. Expecting an IPO, and expecting VC investors to agree, is a recipe for failure.
This remains a good news-bad news situation. The good news is that strong early-stage companies that understand venture capitalists’ expectations are continuing to get funded. Some later-stage companies – and weaker early-stage companies that in a strong economy might still get funded – are finding things more difficult.
In any case, VCs advise that it may get worse all around before it gets better. But mixed with that caution is a sense of optimism. Until the events of the past few weeks, representatives with the National Venture Capital Association predicted that the quality (though not necessarily the quantity) of exits both with IPOs and acquisitions were faring well and “should translate into some much needed confidence for venture-backed companies looking to exit in 2008.”
That is clearly good news. But in the near-term, in a slowing economy, companies that pay attention to their overall business plan and truly understand market and economic dynamics will be the ones that capture the attention of today’s venture capitalists. •
Andrew J. Merken is a partner with Burns & Levinson LLP, a Boston-based law firm with a Providence office, where he represents both companies seeking venture capital funding as well as venture capital firms in making their investments. He can be reached at merken@burnslev.com.
