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"Start-up Valuations Not at Bottom Yet"
August 29, 2002
By Matt Marshall

It's hard to believe there's still air left in the Internet bubble, but that's what the latest venture capital data suggests. If so, things could get worse for high-tech entrepreneurs before they get better.

Sure, a lot of air has been let out already. The valuations on start-ups -- which are the values that entrepreneurs negotiate with venture capitalists -- are declining. That means VCs are paying entrepreneurs less money for an ownership stake.

Median valuations for venture-backed start-ups fell to $10.6 million in the first half of 2002, which is about where they were in 1996, according to VentureOne, a venture capital research firm. That's much lower than the peak of $29.9 million in the first quarter of 2000.

But there's still room to head lower, says John Gabbert, director of research for VentureOne. ``Is the bubble gone?'' he asks. ``That would mean we've hit a bottom. I don't think we have.''

The fall in 2002 valuations comes mostly in later stage financing rounds, or for Internet-era companies that are still trying to raise money even though they're troubled.

But if you look at start-ups funded after the crash, the median ``seed-round'' deal was $3.2 million. That's much lower than the peak of $5 million in 2000, but still higher than 1995's median of $1.8 million. So we're not rock bottom yet.

Some VCs, like Vince Occhipinti, partner of the Woodside Fund, say they're happy with valuations even if they're not as low as they could be. The quality of the deals are better, he says: Management teams are sharper and more experienced, business plans are more focused, and target markets are bigger and real.

But other VCs are insisting on tough terms to make up for valuations that they say are still too high, according to Nancy Schoendorf, of Mohr, Davidow Ventures.

That air suggests that VCs still have too much too spend. That might be what's keeping up valuations: ``There's too much money given today's pace of investing,'' says Gabbert. He says there's enough money to fund start-ups for three years.

In the seed stage, the federal Small Business Administration is helping generate more than $1 billion a year for VC firms to invest small amounts -- $500,000 to $2.5 million -- in Silicon Valley start-ups. The SBA argues that this is the ``weak spot'' in the market that is ignored by bigger venture firms.

But the bigger firms are now returning to their roots, and investing smaller amounts too. Charles River Ventures' Ted Dintersmith says his firm made six investments of about $250,000 over the past year. Vinod Khosla, of Kleiner Perkins Caufield & Byers, says his investments are averaging about $1 million.

True, many ``angel'' investors -- who specialized in giving budding entrepreneurs $1 million or less -- have fled the scene. Ron Conway, who invested piles of cash into Internet-era companies like Productopia, Livemind and Octopus, still has a headache. He's spending all of his time trying to save existing companies: ``My fund is not investing,'' he says.

But other angels are still anointing start-ups at the same old rate: Ram Shriram, who runs Saratoga angel group Sherpalo, helped seed Internet search engine Google in 1998. He's made two new investments this year, or around the same pace he has in the past.

If there are indeed too many players and too much money, then there's still more consolidation to come in the VC world -- which means more pain.

Postcript: TermSheet reported earlier that Los Altos' Aspen Ventures acquired funds from Saratoga's Redleaf Group, as a way to leverage them with SBA matching funds. The name of the merged firm is Aspen-Redleaf Fund. Aspen-Redleaf will keep two Redleaf partners on board.

Contact Matt Marshall at mmarshall@sjmercury.com or (415)477-2518.



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