Raising Venture Capital Looks Bleak

Bill Warner Friday, December 19, 2008

The National Venture Capital Association in its annual Predictions Survey paints a pretty bleak picture of what venture capital is going to look like in 2009. Some think that it is more optimistic than it should be. After all, they cannot be so negative as to further alarm their limited partners.

But, some venture capitalists are saying that this is going to be worse than the dot.com bust of 2000 and 2001. The amount of money invested will drop considerably. The only exception might be the late stage companies that are close to a viable exit, but the valuations for these companies will be considerably compressed. It may be so bad that we will lose many venture capital firms that will either shut down operations or move to other investment instruments. We are already seeing evidence of this movement.

New Investment Significantly Curtailed

At the root of the problem is the reduction of the pipeline of money that comes to venture capital firms in the form of institutional money from pension funds and foundations. We have seen clear evidence that raising money for new funds will be very difficult and commitments for capital for current funds are already being curtailed.

If you have a company that needs its first round of venture financing, you are going to have a very hard time getting it. Only the very best deals will make it as 96% of those surveyed said that it will be much harder to get an initial investment. That’s sugar coating for “forget it.” If you are an existing company that needs a follow on round, you are going to have almost as difficult a time; so says about 93% of those surveyed.

Clean Tech and BioTech are Hot; Semiconductors and Media Are Not

Clean Tech, biotech and medical devices are the only industries that might see a significant increase in investment in 2009. Semiconductors and media, along with wireless and software, will experience substantial decreases in investment. In addition, international investments will decline as well.

Not that a large amount of venture capital money ever goes towards seed round companies, seed and early stage companies will suffer as venture capital firms use more of their money to shore up their current portfolios.

No End in Sight

We are only seeing the early signs of what is happening to the private equity world. The whole venture capital industry is in turmoil and could undergo significant changes in their investment priorities and opportunity selection. This will have significant implication on angel investors who may have to carry more of the load to bring companies through their early life.

Permalink

Raising Angels - Finding Investors in a Recession

Bill Warner Thursday, December 11, 2008

The Angel Capital Association (ACA) has reported a 10 percent decrease in angel investments in 2008 versus 2007. In their recent report, we are seeing the direct evidence and implications of the slowing of angel investment that started in the early fall of 2008, along with a forecast that it will continue through 2009. Nevertheless, some angel organizations have continued to invest strongly through this year and will continue to look at new deals next year. Read the ACA Angel Group Confidence Report

Angel Investors Feel the Recession

The entire private equity food chain is feeling the effects of the economic downturn and the results are the same for angels as they are for venture capital and investment banking. In this case, the source of funds for angels has been squeezed considerably with the market decline, causing them to pull back on making new investments. This is the same effect we see in the private equity firms that get their funds from private institutions whose investment portfolios have been similarly squeezed. Even Silcon Valley is feeling the pinch. As far back as April Tom Foremski wrote about his concern about the loss of angel investors in this recession because they are the front end of lots of venture capital deals. Now it’s coming true.

New Angel Investing Opportunities Exist – Even in a Recession

The most astute angels see opportunity though and FundingUniverse can give you some insight as to how they are thinking. There will be some very good deals to be seen in the coming months as valuations are tamped down and investor preferences are increased. The issue is whether or not they have enough money to make these new deals. The issue they face is that they need to keep more money in reserve to shore up their current portfolio of companies, because their companies are going to have a very hard time raising any new capital in the coming year. Any company that can’t see its way through the end of 2009 with its current capital infusion could be in serious trouble. This is why angels are asking their portfolio companies to tighten their belts by driving sales while cutting cost and expense.

More Syndication Among Angel Investors May Help

The ACA report points out that syndication among angel organizations could become much more important than ever before. The demand for angel financing is going to continue to be strong, but less money is available to invest. By having multiple angel organizations participate in a single investment opportunity, more deals could be made while increasing portfolio diversity and reducing risk.

Early Symptoms of Recession for Private Equity with No End in Sight

We are only seeing the early signs of what is happening to the private equity world. Venture firms are acting like first line managers and focusing on the uses of cash and managing burn rates. The whole venture capital industry is in turmoil and could undergo significant changes in their investment priorities and opportunity selection. This will have significant implication on angel investors who may have to carry more of the load to bring companies through their early life. Stay tuned.

Permalink

Private Equity in a Tsunami

Bill Warner Monday, December 08, 2008

To use an analogy, we have a fault line in the earth’s surface in the credit markets. The pressure became so great between the tectonic plates of home mortgages and bank solvency that the fault line shifted causing a massive earth quake that was felt around the world. The resulting tsunami devastated the shores of the public markets which in turn decreased the value of private institutions and foundations. The tsunami is still reverberating around the world and has now reached private equity firms and individual investors.

Look to Your Government for the Cause of the Pressure

All of this is a result of congress and the administration applying the pressure on banks to make bad mortgage loans to people who couldn’t afford them. Add to that the incentives given to banks to protect them from these bad loans through Fanny Mae and Freddie Mac. This pressure had been applied for over 30 years, since the Carter administration, until finally the fault line gave way causing a massive economic disaster. The shame of it all is that they knew it was coming and did nothing about it; thanks especially to Barney Frank and Chris Dodd. Now our government, who has mismanaged Social Security and Medicare, is going to help to manage financial institutions that they drove to insolvency and potentially the auto industry which they have regulated and maneuvered into uncompetitive and bloated monoliths. God help us. We really need more pressure across more fault lines in our economy.

Private Equity Feels the Pain of the Tsunami

The most recent news in the New Your Times is a case in point. Leon Black of Apollo Group says that “Traditional private equity is dead and has been for a year, and it will probably remain so for a couple of years.” Private equity has enjoyed several very good years as markets expanded. Now with markets declining, many of them are in dire trouble, especially if they have high debt. Some private equity firms are aggressively renegotiating their debt agreements, begging for more time to turn themselves around. The institutions that they rely upon for capital were crushed in the tsunami and are pulling capital out of the private equity markets. This is bad news for companies looking for venture capital financing, because the source of their funds is drying up. Apollo is not alone. Other major players are scrambling including Blackstone Group, Kohlberg Kravis Roberts, and the Carlyle Group.

Private Equity Firms May Rebuild as Something Else

Mr. Black remains optimistic and says he is poised for the further turbulence from the tsunami. He has recently gotten additional funds which he will use to buy cheap debt. He says that the big money over the next few years will be made in vast restructurings; the financial, operational and structural changes that companies will need to make if they hope to survive the economic malaise. He will probably have to start with some of his own companies.

This case in point is simply evidence that private equity firms are not going to stand still and allow themselves to fail. They will move to where the money and opportunity is. Cleaning up after the tsunami might be a very good place to start and hopefully the government will stay out of the way this time.

Permalink

Venture Capital - Who Needs It

Bill Warner Sunday, December 07, 2008

According to observers at TechCrunch there are more signs of weakness in the venture capital world. Private equity in general is very much weaker due to the economic downturn as institutions pull back on their capital commitments and private equity firms reduce their new investments trying to reserve cash to protect their current portfolios. Some institutions are even selling off some of their investments at large discounts. Now we are starting to see increasing layoffs in venture firms as they reduce unneeded staff.

Surviving Without Venture Capital

Another interesting perspective is emerging as seen in Paul Graham’s recent blog. It is evident that starting many online businesses doesn’t take as much capital to get started as it takes a pure software company. Many of the services that an online business needs are already available, like marketing, sales, distribution, payments, etc. Obviously it takes capital to develop the unique aspects of any new service offering, but that is usually the role of angels and friends and family investors, long before any venture firm wants to get involved. This observation coupled with the more astute business experience of today’s entrepreneurs leads many of them to conclude that they do not need venture capital money. Their intent is to get to positive cash flow through grants, loans and angel money.

The Role of Venture Capital is in Question

This perspective applies to the limited number of businesses that don’t require much unique infrastructure to become operational. Because it is now so hard to raise venture capital, many new companies are going to design their business models in a way that will exclude the need for any funding after the seed round. I think we are going to see more news about how the role of venture capital is going to change in this recession.

Permalink

Raising Venture Capital in the Economic Downturn - A Different Beast

Bill Warner Thursday, December 04, 2008

You may run into some articles and reports on private equity that talk about great performance in 2008. The danger is that these reports are usually talking about the first half of 2008, long before the roof feel this summer. Of note is the Venture Capital Deal Terms Report that highlighted the fact that “despite the credit crunch, the fund-raising climate for start-ups remained favorable through the first half of the year.” Well, that might have been somewhat true, but it isn’t any more. Ron Conway seems to agree.

Credit Flow Slows

The “credit crunch” started a house of cards to fall. The credit flow slowed as a result of the greatly weakened balance sheets of financial institutions substantially caused by the rapidly declining value of their mortgage backed securities. This materially hurt businesses of all kinds who needed credit. Then the bailout was proposed and passed, giving the American people the chance to pay for this problem. We then saw the markets fall into the ditch, to the tune of 30%-40% of market value lost.

Private Equity Feels the Pain

That’s all very unfortunate, but how does this affect a company who needs to raise private equity. The connection is that private equity firms (i.e. VC’s and Investment Bankers) get their money from large institutions like pension funds and private foundations. These institutions become the limited partners in private equity funds and have strict agreements with the private equity firms that spell out the kind of financial performance that is required. Unfortunately, these institutions are also heavily invested in the public markets, so their portfolios of investments just got hit with an axe. This is literally causing them to reprioritize their investments in private equity funds, to the extent that they are backing away from previously made investment commitments and actually divesting themselves of these investments. That means that private equity firms will have less money to invest in new deals, and they are putting pressure on their portfolio companies to conserve cash. Your chances of getting another round of VC funding are going to be very low.

Angel Investors More Flexible

The angel investment world is similar in many ways, but not as dire. Angels are investing their own money, so they don’t have the pressure from limited partners that VC’s have. However, their personal portfolios also got hit with that same axe, so they are hurting in the same way that the institutions are. As a result, the same reprioritization is occurring. Many angel organizations are asking their portfolio companies to conserve cash but telling them that they are with them if they need more money. This means that angels are holding money in reserve to protect their current investments, which also means they will have less for new investments. Angels are entirely more flexible and willing to work through this because they can make a unilateral decision about their own money and they invest in start-ups for many other reasons than to just make money. Nevertheless, it is going to be quite hard to raise angel money in this economy, but if you have a business with a lot of potential, you have a chance.

So, be careful about anything you read about the state of private equity. If it has not factored in what is now happening, you are in danger of having a very incorrect picture of your chances of getting angel or venture capital financing.

Permalink

Investing in Alternative Ethanol Fuels

Bill Warner Wednesday, December 03, 2008

What is happening to the ethanol business in the US? What did we get for the increase in grocery prices? Not much except for a higher cost of living and no corn. Ask anyone in the restaurant business what they think. Well, private equity investors aren’t too happy either. VeraSun is bankrupt, Aventine Renewables is trading at less than $2 per share and Hawkeye Holdings wasn’t even able to price its IPO. There continue to be reports that a gallon of ethanol takes more power to produce than it actually creates. Now with lower oil prices, the price of gasoline is hard to beat. Could it be that ethanol is not the right way to go?

Private Equity Bailing Out of Ethanol

Ugh, this is not what the “clean fuel” guys want to hear. Basic economics doesn’t seem to matter to them as they pursue their misguided view of the right alternative to reducing our dependence on foreign oil. This whole movement has been characterized by “firing now” and “aiming later.” Drilling for oil now and exploiting our natural gas potential is probably the best route to a practical approach to reducing our dependence while investing in sensible energy alternatives and maintaining some semblance of economic stability.

The private equity folks seem to see it that way too. For example, the Paladin Capital Group is leading the formation of a new ethanol production and infrastructure platform, called Vital Renewable Energy (VREC). They are assembling hundreds of millions with other participants being Leaf Clean Energy Company, Petercam Asset Management and PCG Clean Energy & Technology Fund.

Ethanol Investment Moves South

The interesting thing about this is that they are avoiding two major problems with this industry: the United States market and using corn as the basis for production. Instead, the company will focus exclusively on the Brazilian market, which is almost entirely based on sugarcane. Other private equity firms are poised to follow this same model.

The Brazilian ethanol market is booming, due to both the cost-effectiveness of sugarcane and a national adoption of ethanol as the power source of choice. No such commitment has ever been made in the US. Ninety percent of new cars sold in Brazil are flex-fuel, and new plants keep popping up to satisfy demand. VREC will focus on building new production plants, which will include co-generation facilities that can sell gas byproduct into the Brazilian power grid as well.

Lessons Learned from Corn-based Alternative Fuels

The U.S. ethanol experience, while characteristically distinct from Brazil, has scared off a bunch of would-be investors. Private equity investors ran to this corn-based alternative like thirsty cattle in the desert. It appears that not a lot of due diligence was done to assure themselves that they had the right business model and national infrastructure to make it work. Now with gas prices falling below $2.00 per gallon, the economics are even less attractive.

This is not to say that there is not a workable ethanol business model. It does say that corn is probably not the right foundation and that the US may not be the best place to start. Think of the opportunity for other South American countries as well as Southern African countries, where sugarcane can grow the best. Investments in production facilities could mean a brand new economy for these countries, and US investors can participate in making it happen. Meanwhile, let’s drill for some oil and natural gas, and dig for some more coal, in which we have abundant reserves.

Permalink

Raising Capital - Private Equity Gets Tighter

Bill Warner Wednesday, November 05, 2008

More evidence is mounting that private equity is going to be increasingly harder to get. Yesterday’s Wall Street Journal had a cooling article about how large institutional investors are starting to be much more cautious with their investment strategies.

Also, pension funds and large foundations, the limited partners of private equity firms, are starting to turn down the opportunities to make investments in private equity firms. These limited partners are feeling the pain of the market downturn as a result of the reduced confidence in the economy and are reprioritizing their investment strategies. The article cited some examples:

  • California Public Employees’ Retirement System, one of the largest pension funds, is asking its private equity firms to “ease off on requests” for additional capital.
  • Harvard University is seeking to offload $1.5B in private equity investments.
  • Kohlberg Kravis Roberts, who has been trying to go public, has reduced the valuations of several of its largest holdings.
  • The market value of public private equity firms is falling like a rock, far greater than the overall market.
  • The market selloff is putting some institutions in danger with oversized allocations of private equity investments.
  • Many firms, like Madison Dearborn Partners are reducing the amount of money they are raising for new funds.

This is all eating away at the foundation of a house of cards. Follow each of the falling cards:

  • As institutional money tightens, less money will go to the private equity firms (VC’s).
  • The private equity firms will have less money to invest in companies, so that only the best of the best will get institutional financing as the hold more and more money to protect their portfolios.
  • Angel investor backed companies, or any other companies that are expecting institutional money, are going to have to lean on their current investors to give them additional life.
  • Angel backed companies are also going to feel a lot of pressure to conserve cash in order to lengthen the runway they have before needed any additional financing.
  • Finally, angel investors are also feeling the same pinch that institutions are feeling. Their portfolios are squeezed and may have to reprioritize to less risking investments.

This is not good news for entrepreneurs, especially those who have companies that are strained for cash and in need of additional financing now. I just met with an early stage company this afternoon that has been stalled on getting a VC investment as the VC firm tries to close on a new fund from their limited partners. Who knows if they will ever see closure.

Permalink

Angel Investment - Harder to Get For Entrepreneurs

Bill Warner Sunday, November 02, 2008

In the midst of this economic mess, entrepreneurs wonder what the heck just happened to their chances of getting angel financing. They have done all this research on their business, proven that their business idea has commercial merit, gotten grants to assist them in the early process of forming their business, gathered friends and family financing to get into a position to be able to launch their companies and now are faced with the end of the road before they get a chance to go to market.

Getting needed financing is always tough, but now it is going to be even tougher. Here’s what they are faced with:

  • Government budgets are going to come under scrutiny which will impact the lucrative grant programs that are available today. This means that the proposals that are submitted for these programs have to be even more compelling and address a strong and urgent need.
  • Foundations whose investments are also in the public markets are going to experience lower returns which will reduce the amount of money they will be able to offer to new business ventures. As with government grants, the pressure is on the entrepreneur to have a stronger and convincing story to justify the foundation grant.
  • The limited partners of venture capital firms will also feel the pinch in the markets, putting further pressure on venture firms to perform. Raising further funds from limited partners for venture capital will be more difficult as well. As entrepreneurs approach venture firms, they are going to have to show greater returns over a shorter period of time, and the risks have to be well mitigated.
  • Angel investors will back away from new investments, unless they see a clear winner that they will be able to get into at a very attractive price. Start-ups are going to have to show a very attractive market opportunity and accept lower pre-money valuations as they have to offer more of their company in order for investors to mitigate their risk.

All of this means that entrepreneurs are going to have to be a lot more diligent. Agencies that offer grants, angels and venture firms are going to be much more selective. Here’s how entrepreneurs are going to have to react:

  • Entrepreneurs will need to propose businesses that reach profitability and positive cash flow much sooner than ever before, because they are going to have less money to get their companies launched.
  • Their business models will have to be focused and the path to revenue will have to be very convincing, supported by early customer feedback and rapid marketing and sales progress.
  • The financial pro forma will get a lot more scrutiny, with emphasis on solid cost and expense planning and a clear eye on cash flow management.
  • Angels will spend more time reviewing financial performance, so entrepreneurs will have to prepare for more scrutiny on how their money is being spent.
  • For the limited amount of credit that will be available, the terms for borrowing money for new equipment are going to be more onerous, almost making it worse than spending valuable cash to purchase equipment outright. In the same manner, leasing will become tighter as well. Entrepreneurs are going to have to be even more inventive about finding used equipment or align themselves with partners to share in the use of equipment. Outsourcing the need to companies who have it will have to be a strong consideration.
  • Entrepreneurs are going to have to establish strong credit, mainly through the credit worthiness of the company’s founders and of the company’s business partners who are willing to back them.
  • For the many rapidly growing companies who need to partially finance their early success through AR financing, they will see even tighter restrictions on the quality of AR backing. Entrepreneurs will need to negotiate more attractive payment terms with suppliers in order to survive, or choose to grow slower, within the limits of their cash flow.
  • Lines of credit, the vehicle by which short term cash demands for payroll and other payables are sometimes met, are going to be tougher to get, putting cash-squeezed companies at great risk. This too will force entrepreneurs to reconsider payment terms and other means of conserving cash will be even more important.

Entrepreneurs have to become strong business people. More and more will have to partner with seasoned business people in order to establish the management team that will not only develop the business idea but also bring it to a rapid business success. Strong management teams nurturing great ideas will undoubtedly pull us through this newest burst in our economy’s bubble.

Permalink

Angel Investors Want Disciplined Entrepreneurs

Bill Warner Friday, October 24, 2008

With credit tightening and the markets crumbling, entrepreneurs are facing a rapidly increasing competitive situation when vying for angel money. Angels are going to be a lot more selective and pick only the best opportunities, with best being defined to be:

  • Quick to profitability
  • Quick to positive cash flow
  • Quick to exit
  • Managed by an extraordinary team

So what is new about all that? Nothing really, but the pressure to be right and to really achieve it has gone up an order of magnitude. Entrepreneurs are going to have to make fewer mistakes, because there is not a lot of room for more financing to make up for them.

Angels are different than institutional investors. Institutional investors, like venture capital firms, have limited partners that provide the funds under certain financial performance terms. Angles are investing their own money. Angels care about their portfolios in many of the same ways as institutional investors, with one exception. Angels have a deep desire to see the entrepreneur become successful, and will be very much more forgiving, flexible and supportive during tough times. They, like the entrepreneurs, are the ultimate risk takers with a passion for the business surpassed only by the entrepreneurs themselves. But, like the institutional investors, they want to make money.

Raising angel financing is going to be much tougher, which will require entrepreneurs to present a very compelling business proposition that materially demonstrates a plan for rapid success:

  • The description of the market will have to be well vetted. Paper analysis will not be good enough. Entrepreneurs will have to show that they have really tested their market entry with real customer feedback and survey results. If angels cannot see and talk to real and potential customers, the entrepreneur may be passed over.
  • Entrepreneurs better know their competitors’ businesses about as well as they know their own. No more passes on competitive matrixes full of yes’s and no’s, and loosely spelled out SWOT analyses. Angels will need to see examples of competitive situations where you are winning as verified by customer feedback. It can’t be just the entrepreneur saying they have a winner. A buyer or potential buyer will have to say it.
  • Marketing strategies are going to have to come alive with real contact information and lead generation productivity assumptions that have been verified by test marketing programs. The Excel spreadsheets will still be needed, but verification of the assumptions will be required.
  • Sales targets have to be substantiated with an emerging pipeline of sales prospects, some of whom having been contacted and will verify their interest in the entrepreneur’s product or service. A verifiable list of additional sales targets have to be shown that demonstrate great confidence that the first year’s sales targets can be met. It is almost like the company has to have a rocket loaded with fuel and the entrepreneur has the match already lit to launch it.
  • The financial forecast is going to have to be well thought out, demonstrating that the entrepreneur knows how to manage cash. Sold estimates for cost and expense, along with capital purchases, will have to be verifiable. The sales estimates have to correlate with the sales targets in the marketing and sales plans.
  • The management team has to be very strong. First time entrepreneurs are going to have a tough time getting financing without having a seasoned executive at the helm. Angels will want a management team with a proven track record and relevant industry experience. These are the people that will mitigate a substantial part of the risk the angel is taking.
  • Due diligence will become much more thorough. In addition to the usual process, much more scrutiny will be put into customer feedback, alliance relationships and credit worthiness of the company and its backers. Angels are going to have to have organized due diligence material, showing that the entrepreneur has a good handle on the business and what drives it.

If they haven’t done so already, entrepreneurs should be looking for assistance from seasoned business professionals to help them not only get ready for angel investors, but to help them run their companies efficiently and effectively. Entrepreneurs that form the right teams are the ones that are going to get the gold.

Permalink

CEO Coach - Orders For The New Economy

Bill Warner Wednesday, October 22, 2008

Credit is flowing slower than tree sap in a New Hampshire winter. The board of directors demand actions to respond to the economic mess and wants everything to happen immediately. Investors want to save cash and get to exit as quickly as possible. New investors are renegotiating their terms or backing away all together. Customers are starting to reprioritize purchases they had previously committed to. Wow, it’s a great day in the life of a CEO.

Let’s take a breath and not panic. Action certainly needs to be taken and it is very much the same thing that a CEO has to do in a turnaround situation:

  • Reassess where you are with your revenue forecast. Talk to your most loyal customers and reassure them that you will be there for them and see where they are on future purchases. Take a hard look at new customer purchasing to verify that purchasing timeframes are still real. Adjust the revenue plan based on this brutally honest near-term view of customer purchases.
  • Tighten the belt on the cost structure of your products and services. It’s time to take cost reduction actions that will provide a short-term yield. Cut personnel that are not essential to the manufacturing of products and to providing services.
  • Take a hard look at expenses looking for ways to save cash on discretionary spending, payment terms to suppliers, lease payment terms, unnecessary personnel and even look at stabilization of salaries. If an expense item is not serving the main mission of the company, question it.
  • The conservation of cash is what this is all about. More drastic actions could include the curtailment of development of future products and getting out of markets and discontinuing customers that are not profitable. Any action like this has to be done in the context of the company’s cash position and a judgment made as to whether there is enough cash in reserve to take the company through these hard times which could last through all of 2009.
  • Rerun the income and expense report, cash flow statement and balance sheet forecasts with the operational changes you have made. Take a hard-nosed look at whether or not you will have enough cash to sustain your business. If not, more cost and expense is going to have to be removed from the business, which might mean you have to change the fundamental strategy of the business. You must get cost and expense in line with your realistic view of the revenue outlook.

You may be faced with the need to raise additional funds to get you through these tough times. Do not go to outside investors without having first done your homework. Bank loans are much harder to get, but if you have a realistic financial outlook and satisfactory past performance, you have a reasonable chance of getting help. If you have angel investors, you need to work closely with them and give them the same brutally honest view of the business and ask for their continuing help with additional funds. If you need to get institutional money (VC’s), you are faced with a tough negotiation.

This is going to be survival of the fittest, requiring much more discipline and focus than ever before. The necessary actions are well known. We have been through this before. The difference will be in the execution of what needs to be done.

Permalink

Page 5 of 7 pages « First  <  3 4 5 6 7 >