A year ago, venture capitalists were the rock stars of the New Economy, trafficking millions to startups they hoped would reap billions. Well, the party's over and the hotel room's trashed with dot-com wreckage.
Ask VCs today about investing in the latest dot-com startup, and they will echo George Bush Sr.'s famous line: "Wouldn't be prudent." The lesson learned from the investment mania of 2000 is that it's time to return to time-honored investment basics. Prudence is the way to go.
"Last year, if you were a startup claiming to offer a service that was faster, cheaper and the first to market, you had a model that many VC firms would throw money at," said Massoud Entekhabi, managing partner with Santa Monica-based TL Ventures.
The amount of venture money that was tossed to L.A. businesses climbed from less than $30 million in 1993 to almost $2 billion in the first nine months of 2000 alone. (Fourth-quarter figures are not available yet.)
Consider some of the dubious investments during the fourth quarter of 1999. Culver City-based CarsDirect.com, a site where you can buy cars and get financing information, got $280 million from firms such as Hambrecht & Quist, Goldman Sachs and others; the company recently dropped its IPO and announced layoffs. BizBuyer.com, a B2B marketplace that closed its doors last month, got $38.5 million from Redpoint Ventures and others. eStyle Inc., an operator of B2C-oriented sites, got $25 million from Zone Ventures, Vulcan Ventures and others.
Would companies like that get that kind of funding in today's marketplace? No way.
"The idea that a company can aggregate eyeballs and figure out how to monetize them later, which was popular in the (recent past), has gone away," Entekhabi said.
Instead of doling out checks to those startups and waiting for an IPO, VCs are returning to traditional, established practices.
"They're returning to the obvious and very successful fundamentals," said Rohit Shukla, CEO of the L.A. Regional Technology Alliance. "The fundamentals are simple and they've never changed: revenue, growth and profit."
"Private equity investors are more focused on investing in a business opportunity that has a sustainable, supportable, unfair advantage in the marketplace," Entekhabi said.
To meet those criteria, local VC firms will have to acknowledge that innovation is happening globally.
"Venture capitalism has always been local," Shukla said. "The truth of the matter is that, with their extraordinary funds, local VC firms need to find innovation wherever they can find it in the world and bring it into their portfolios."
Those companies should also be immune to stock market volatility.
"They need to make sure their companies have a revenue and profit base that grows in spite of the stock market, not because of the stock market," Shukla said.
This year will also be the year that VC firms return to their expertise.
"A lot of firms got caught up in the frenzy of the day and tried to reposition or expand their investment strategies. While a few were successful, a lot of people are going to look back and say, 'Gosh, I wish I hadn't done that,'" Entkabi said.
Is money going to be tight for VCs in 2001?
"There's a lot of money sitting on the sidelines right now looking for a home," said Entekhabi.
Redpoint raised $1.25 billion for its latest fund, according to the firm's managing partner, Brad Jones.
Indeed, no local VC firms are going to go belly up. Unlike many Net startups biting the dust, most VC firms are structured to stay solvent during economic downturns. VC firms usually have 10 years to manage their portfolios before returning money to limited partners pension funds, wealthy individuals and institutional investors.
But now that the Net bubble has been pricked, VCs are taking a more sober, long-term approach.
"We're in the long-term investing business," Entekhabi said. "If we have short-term swings in the value of our portfolio, we'll still have a good investment in the long run if our underlying criteria are still there."
VC firms that were started in the past year by amateurs will face hard times. Without a proven track record, they'll have a tough time raising follow-on rounds, because their portfolios aren't proven.
"Not everyone can ever be a venture capitalist," Shukla said. "It requires a special kind of skill. It's way more than just shoving money down a bottomless pit."
If there is a buzzword in the VC community today, it's infrastructure.
"There is more focus now on companies that have unique technology that gives them an advantage," said Redpoint's Jones. "There's a return to analyzing proprietary technology. With that, we will continue to invest, but I think at a little slower pace."
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