Venture capitalists regroup

$1bn a week was offered to dot.com entrepreneurs

By BBC News Online's Steve Schifferes in Silicon Valley

The venture capital industry has been one of the keys to Silicon Valley's success.

Venture capitalists supply the funds to budding entrepreneurs who want to start their own companies - and 40% of such deals in the US take place in Silicon Valley.

Ann Windblad's company with $1bn in funds under management, was one of the victims of the dot.com fall-out

Venture capitalists also help nurture those companies to success, supplying introductions to potential customers or partners, assistance with raising more funds, and even management support.

And venture capital has been one of the extraordinary growth industries in the Valley, with the amount of money invested in venture capital funds rising in the decade from $1bn in 1990 to $20bn in 1999 - and nearly doubling again to $35bn in 2000.

But in the last few months, the volume of venture capital deals has slowed sharply - with only half the number of early stage companies funded in the Bay Area compared to the previous quarter.

Dot.com fall-out

Ann Winblad, founder of venture capital firm Hummer Winblad, with $1bn in funds under management, was one of the victims of the dot.com fall-out.

Her company had backed one of the biggest and most well-known internet companies selling to consumers, Pets.com, which stopped trading despite millions of dollars in private investment and an enthusiastic stock market flotation.

In her sleek, wooden-beamed offices in San Francisco's newly fashionable SoMo district, which has become a beacon for dot.com companies, she explained what went wrong.

In her view, the increasing frenzy in the stock market for internet companies - whatever their business plan or chances of profitability - had meant that too many companies had been funded and brought to the stock market too quickly.

Too many inexperienced people came into the venture capital marketplace, with financiers, bankers, and big companies all prepared - even desperate - to back internet ventures.

Fund raising difficulties

At one point, she says, $1bn a week was being offered to entrepreneurs - attracting too many people who were "mercenaries not missionaries" to the world of enterprise.

But when the market woke up, and dot.com and tech stocks crashed in April, it became impossible for even well-managed internet companies to raise additional money.

Pets.com and other e-tailers needed more capital to grow - and that was no longer available at any price.

Now, she says, it is unlikely that anyone would fund any internet company for at least the next two years, and e-tailers, or dot.com companies selling to consumers, are the "mad cow disease" of the venture capital world - no one will touch them at all.

And in future, the pace of investment will be slower and more measured, taking 3-5 years to bring companies to the stage at which they can be floated on the stock market - and that venture capitalists will resume their role of "company coach" rather than pure deal-makers.

Slower pace

Other well-established venture capital firms agree.

Bay Partners in Cupertino sits across from headquarters of Apple Computer.

It focuses on high-tech start-ups in the telecoms field - avoiding the internet field - and has just raised $475m from banks and big companies for a new fund.

Loring Knoblauch, one of the firm's partners, says that they have deliberately limited the size of the fund to ensure that each partner can give proper attention to a small number of companies they intend to nurture - no more than 6-8 for each partner.

He says that too many venture capitalists stretched themselves too thin, funding so many new businesses that they could not properly look after them when the downturn came.

Profit hopes dimmed

And now, one of the factors limiting the further expansion of venture capital firms is their need to spend more time managing their existing portfolio - "tending to the sick and needy" in the words of the chief of one dot.com that has survived, Obongo's John Hunt.

Bob Williams of Bay Partners says that venture capitalists are also looking to collaborate more with other venture capital firms, reducing their own risk by insisting on at least two other investment partners before agreeing to back a new company.

And they are spending more time ensuring that their own companies will be able to get additional funds to grow and expand.

Mr Knoblauch says that in the height of the euphoria one year ago, venture capitalists began to believe that they could make a profit on nearly any company they backed.

But now, they expect only about one in five of the companies they back to become a major success - but those successes, with returns of 10-20 times investment, will still make the whole fund profitable.

Vital role

Venture capitalists will still play a vital role as catalysts for Silicon Valley's future.

It was the presence of the world's most sophisticated venture capital industry that attracted John Hunt of Obongo from the UK to San Francisco.

Venture capitalists have played a crucial part in launching his company, which provides the software for electronic wallets used for shopping on the internet.

Obongo was created in the offices of venture capital firm Sequoia, who introduced the UK based company, then called Smartport, to its Silicon Valley rival, Chabi - and they agreed to merge with each other 30 minutes into the meeting.

Sunny outlook

And Obongo's other venture capital partner, Atlas, played a central role in helping them secure their first customer, the large US bank Citibank.

It is networks like these which will secure the future of the Valley, according to historian and city planner Anna Lee Saxenian.

Nowhere else have venture capitalists such a close connection with their industry, she argues, with most moving from being entrepreneurs themselves.

Their understanding of the technology, the markets, and the competition means that entrepreneurial knowledge is shared and is transferred more quickly here than anywhere else.

It is that culture that will ensure that, despite the sharp change in market sentiment, Silicon Valley will remain the world's high-tech incubator.