At a time when financiers are increasingly tight-fisted toward businesses seeking multimillion dollar loans or investments, Paul Minor feels fortunate that his tiny tech startup is only in the market for $1.5 million to fuel its next stage of growth.
For the chief executive of Tarzana-based iPhotoMeasure, that means drawing on venture capitalists because they rely largely on private investors for their funds and were being nudged aside during the private equity boom.
"If we were a larger company I'd be a little nervous," said Minor, whose company makes software that can precisely measure the dimensions of a room and other objects from a digital photo. "But venture capital, like the (early) B round we'll be seeking this fall, looks like a good place to be right now."
Indeed, the hands-on, entrepreneurial niche filled by early stage venture capitalists and individual angel investors is one of the few financial sectors likely to emerge relatively unscathed or even stronger by the tightening of financial markets in the wake of the mortgage lending industry collapse.
Venture capitalists nationwide invested $7.1 billion in the second quarter the most since the third quarter of 2001, with nearly $1 billion of that amount going to Southern California companies, according to the Pricewaterhouse Coopers MoneyTree Report. And in a reverse of a trend toward caution seen since the dot-com bust, investors appear more likely to take a chance on a brand-new company.
"We are very, very, long term, and the type of deal we do is not reliant on access to debt," said Greg Martin, a partner at Los Angeles-based Redpoint Ventures, an early backer of the MySpace social networking site that was eventually acquired by News Corp. and is now based in Beverly Hills.
On the other end of the VC spectrum are larger growth companies that might be a funding round away from a public offering or an M & A; deal. In that sub-market, traditional VCs are facing increasing competition from private equity firms seeking higher returns and getting frustrated by the decreasing opportunity to use financial leverage to cut a deal.
"We certainly don't compete with them for deals because, fortunately, most of our companies are raising (early stage) series A or B money when we get involved," said Phil Ressler, chief operating officer at Santa Monica's Clearstone Venture Partners. "The kind of risk we take on is not in the sweet spot of most private equity firms. They're more competition for a venture firm that does late-stage deals.
Ressler, whose firm's investments have included United Online and Overture Services (now Yahoo Search Marketing), notes that other venture firms now raising new funds are having some difficulty because of the increased competition. "Fortunately for us, we're not in the market raising a fund right now," he said.
Robert Whyte, managing partner at middle market investment bank Mosaic Capital LLC, said the tightening of credit markets means that private equity won't turn up its nose at companies with $25 million to $75 million in revenue, even though those deals are far less liquid than syndicated billion dollar acquisitions.
"A lot of these larger VC funds would like to see the private equity guys go away, but I don't see that happening," Whyte said. "You've got these private equity guys in West L.A. with lot of money to put to work before the end of year, or they don't get their 2 percent. In the current environment if they can do five small deals for the same amount as one big deal and spread the risk, they'll go for it."
Redpoint's Martin agrees, even noting that he wouldn't dissuade a client that has substantially grown from considering a hedge or late-stage fund infusion as long as it's understood the investors won't bring much else to the game.
"They have to understand that it's a passive investment," Martin said. "When you take money from later-stage funds you can't expect to get the kind of help we can provide. A private equity firm also wants more near-term liquidity, and they're willing to pay a higher valuation to get it. We tend to get involved when the company is several years from even having a product to sell."
Martin said it's unlikely that the venture capital industry will see a significant influx of refugees from out-of-favor financial sectors.
"Venture capital is such a specialty type of investment, more visionary than based on fundamentals, that it's not a business that you can pick up right away," he said.
Even so, the current upheaval in the credit markets is creating other opportunities for an assortment of firms and high net-worth investors with lots of liquidity, said Todd Shoemack, an early investor in iPhotoMeasure and president of Venture Capital Consulting, a Santa Monica firm that helps small companies with the fund-raising process.
"The real market opportunity is going to be for people with cash or their financing lined up for them," said Shoemack, who is watching for opportunities that may appear over the next few months. "It's cherry picking time, particularly for distressed assets. In both 1987 and 1998, the big market corrections came in the fall. So with the current volatility in all the markets, this going to be an interesting time."
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