Stage Startups Face Funding Block
January 24, 2002
By Katherine Goncharoff
When Advanced Reality Inc., a one-year-old collaborative software
startup, went hunting for first-round private financing last year,
it didn't waste much time with traditional venture capitalists.
"Many VC firms were distracted and not that interested in
early stage investing," said Advanced Reality financial consultant
The Houston company quickly changed tack, and in three months,
raised nearly twice what it expected $2 million from
It's an oft-repeated story these days, and one given added pathos
with new statistics from Venture Economics showing that early-stage
fundings by traditional VC firms have nose dived. In the fourth
quarter of 2001, early- stage startups received just 9% of overall
investments compared to 25% on average over the past five years,
the research firm said.
"We've seen pretty dramatic declines in terms of the ability
of early and seed-stage companies to whet the appetites of venture
capital investors," said John Fitzgerald, president of Katalyst
llc, which acts as adviser, agent and investor in early-stage companies.
Added Ronald Weissman, a VC with Apax Partners in Palo Alto, Calif.,
"There was certainly a wild exuberance two years ago for early
stage companies but that time has come and gone,"
Several factors contribute to the decline, notably an overall drop
in venture investing, the difficulty large funds have in devoting
time to manage needy startups and the closure of several funds.
Further, VC firms are forced to devote more time to their portfolio
companies to keep them alive, grow their customer bases and achieve
revenue until they can exit them through an initial public offering
"We're seeing a lot of portfolio drag in the VC community
at large where investors are spending a great deal of time working
out problems and as a result, they don't have a whole lot of time
to look at new opportunities," said Daniel Ahn, a managing
director at the Woodside Fund, a Woodside, Calif.-based lead sponsor
of the Early Stage Venture Capital Association, a national networking
Doug Chertok, a venture capitalist with Hudson Ventures in New
York, noted that many venture investors are concerned about providing
enough capital to their investment targets to ride out the recession.
"Almost by definition, it is difficult to give a lot of money
to an early stage company these days because while you want them
to have enough money, you also have to allow the founders to retain
enough equity to have the incentive to build a successful company,"
Chertok said. "In this environment, that's not easy."
Moreover, the economics of early- stage investing is no longer
viable for the 30 or so venture funds that have each raised $1 billion
or more in the past few years. Many of these funds are inclined
to make larger investments in later-stage companies that do not
require the time and effort to nurture and manage early-stage companies.
Exacerbating the early-stage retreat is that most venture firms
have simply cut back on overall investing.
David Barry, a vice president at Asset Alternatives, noted that
big early-stage funds made very few investments last year overall.
Palo Alto, Calif.'s Accel Partners made only four new investments,
compared to 24 in 2000, according to its Web site, while Barry said
Waltham, Mass.-based multi-stage fund Battery Ventures made nine
new investments last year against 29 in 2000.
Investors also cite the recent shuttering of early stage and accelerator
funds. Earlier this month, The Barksdale Group opted not to raise
a second fund and wind itself down, and Mohr Davidow Ventures said
it would cut limited partners' contributions to an $850 million
fund back to 80%s.
"We are in the early stages of a shake-out in the industry
and a lot of early stage funds have or are in the process of closing
down," Ahn said.
Despite the dire statistics, some venture capitalists are optimistic.
"I think early-stage investing will be on the rise in 2002,"
said Ravi Mohan, a Battery Ventures partner. "A great many
good companies that already had product and revenue and were priced
as though they were early stage deals got funding last year. But
the good ones have already been funded and so, I think that more
VCs will now turn to early stage funding," Mohan said.
Apax's Weissman agreed, "For us, this is a great time to be
an early stage investor because the valuations are great and there
are wonderful management teams available for hire."