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Adventuresome Ventures
Slowed economy hasn't stanched VC investment in state
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Business New Haven
5/14/2001
By: Susan Cornell
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The year 2000 was a record-breaker for investment in venture-backed companies, according to the first combined results released by the PricewaterhouseCoopers Money Tree Survey.
Total investment reached nearly $70 billion nationwide last year, an 80-percent increase over the amount venture capitalists invested in 1999. Venture Economics (VE), the foremost information provider for private equity pros, and the National Venture Capital Association (NVCA), an organization representing more than 420 venture capital and private equity firms, also announced that venture capitalists continue to invest at an extremely healthy rate; the VE and the NVCA figures indicate that total venture-capital investment in 2000 reached $79.9 billion, despite the softening economy.
PricewaterhouseCoopers reports that venture-backed Internet companies had a remarkable year as well attracting $56.9 billion for a 92-percent gain over 1999. NVCA and VE findings announce that such companies continued to attract more than 40 percent of all venture investment in the last quarter of 2000. While many believe that Internet investing is passé, the NVCA and VE figures reveal that the venture capitalists' focus is moving toward technologies and new business models that will propel Internet development forward.
However, PricewaterhouseCoopers reported in February that, after five years of steady growth, investment in Internet-related companies declined as a percentage of the total for three consecutive quarters and now comprises 80 percent of overall venture investment.
Nationally, PricewaterhouseCoopers reported that investment in e-commerce companies declined by 92 percent while business services, which at one time attracted roughly half of all Internet investment dollars, continued a steady decline to half of its first-quarter 2000 high. Information technology companies accounted for two-thirds of the total amount invested in the fourth quarter last year, while semiconductor investment remained fairly stable. Networking and communications investment declined only slightly.
Health care experienced a record-breaking year. Biopharmaceutical companies posted an 86-percent increase between the fourth quarter of 1999 and the fourth quarter of 2000. PricewaterhouseCoopers MoneyTree Survey in partnership with VentureOne unfurls the venture capital investments by industry for Connecticut for the fourth quarter of 2000 as follows:
Northern California companies continue to attract more than a third of all venture investment. However, New York and New England are in a battle for second place, attracting 11.8 and 10.2 percent, respectively. These areas both witnessed a growth rate of more than 125 percent comparing 1999 investment levels to 2000 investment levels. Interestingly, the growth rate of venture capital in New England was greater than it was in northern California between 1999 and 2000.
According to the NVCA's National Venture Capital Profile (July 1 through September 30, 2000), Connecticut ranked 13th in VC investment by dollars, and 16th in such investments in Internet-related companies. The state ranked eighth in money raised by venture capital funds. New Haven County was ranked 63rd in VC investments among top 100 U.S. counties.
Why is the Northeast considered one of the hot growth regions of the 21st century, providing venture capitalists with so many solid investment opportunities? According to the latest Milken Institute study, the Northeast is home to five of the top ten states on the Institute's New Economy index that ranks each state on criteria critical to future high-tech growth (Connecticut is No. 3). According to the Progressive Policy Institute, Connecticut ranks among the top five in preparedness for the technology-driven New Economy and the state's computer services industry outpaced all others in the 1990s. The MoneyTree Survey paints the picture of the in-state success story.
In Connecticut, the news was upbeat as 13 companies attracted more than $98 million in venture capital funds during the fourth quarter of 2000, according to PricewaterhouseCoopers. The largest fourth-quarter deal in state was a $27 million investment in CentrPort, a Westport-based provider of marketing analysis platforms. Stamford-based zUniversity, a developer and operator of customized Web communities, received $15 million.
Two other Stamford companies, FitLinxx and iSolve, tied for third place recipients obtaining $11 million each from investors.
Greater New Haven is a prime location for VC investment. First, there is the $1 billion in biotech investments made in the metro area since January 1, 2000. The Milken Institute considers New Haven one of the top 25 technology centers. The New Haven metro area is home to over 45,000 students. There is the $1 billion investment in engineering, science and technology at Yale and elsewhere over the next decade. Finally, the latest Dynamic Resource Solutions report shows that the area has the second highest concentration of high-tech jobs in the U.S.
It is fitting, then, that New Haven was chosen to host Crossroads, the Northeast's premiere venture fair, which offers venture capitalists the opportunity to examine investment opportunities from across the Northeast (see related story, page 17).
“Crossroads' decision to choose New Haven as its home is further evidence that New Haven has become a hotbed of new technology, a great place to build a business and a prime location to invest money,” says New Haven Mayor John DeStefano Jr. “High-tech and biotech firms in the city raised over $1 billion last year, and this year looks to be even more promising.”
While Crossroads is regional, the vast propensity of applicants come from Connecticut. Investors, too, are drawn primarily from the eastern region of the country. Expanding in this way attracts additional investor attention and gives Connecticut companies more exposure because the event is able to draw those in the tops of various fields.
Owen Davis, a partner with PricewaterhouseCoopers who leads the emerging technology practice primarily for southern Connecticut, feels that the future of VC in Connecticut is “very bright because of the strong educational system and quality of life.” Davis points out the state's history with venture capital over the past three years.
“In 1998, there were 41 deals totaling $228 million,” he says. “In 1999, there were 46 with $508 million invested. In 2000, there were 67 deals totaling over $1 billion.”
Davis notes, however, that with the current slowing economy there is also a slowdown in venture capital investment. He believes that Connecticut will “reach a new plateau or a downturn in 2001. Nonetheless, levels will still be higher than three to five years ago.”
The Connecticut Venture Group's Frank Marco, too, uses the descriptor “very bright” when discussing the state's VC future. On the state's side he finds two ingredients are present: location and the tremendous amount of VC money. Add to the picture a supportive governmental sector, prominence of top research facilities, and the fact that “Connecticut is a knowledge-based state, and we have the ability to succeed at the beginning of the pipeline. “Entrepreneurs have a better way of doing things,” adds Marco. “Historically, the culture not been terrific for high-tech. But, the culture is changing. We are moving away from an economy of defense and insurance and seeing entrepreneurs and people willing to take risk.”
With regard to the slowing economy, Marco acknowledges that we have an “adjustment period - but that's only part of life in this kind of system. Even with slowing of economy, in six months or nine months it will turn because tech is such an important sector.”
VC's surrogate name - risk capital - reminds investors and entrepreneurs alike that the downside, risk, is omnipresent. A clear understanding of the process involved and the research required is imperative. From the entrepreneur's perspective, targeting the right venture capital partner is a critical part of fundraising.
The criteria for selecting the right venture capitalist include their industry specialization, the size of investment, geographic, and stage of development preferences. The entrepreneur need also consider whether the fund will act as a lead investor.
A typical venture fund invests in perhaps 20 to 30 companies, so each investment must be carefully selected. Since venture capital fund investors have specific requirements for their return on investment, the venture capitalist must evaluate investments with similar return-on-investment considerations.
Many VC investors expect an annual rate of return of 30 percent to 40 percent or more and a total return of five to 20 times their investment. Both venture capitalists and entrepreneurs should perform due diligence. Questions to consider include:
n Do the venture capitalists have experience with similar types of investments?
n Do they take a highly active or passive management role?
n Are there competing companies in the portfolio?
n Are the personalities on both sides of the table compatible?
n Does the firm have strong syndication ties with other venture firms for additional rounds of financing?
n Can the venture capitalists provide contacts for distribution channels and executive search?
The venture capitalist also needs to determine the value of the “investee.” According to the PricewaterhouseCoopers Entrepreneur Resource Center, “The most important factor in determining this 'premoney valuation,' or the value of the venture prior to funding, is the state of the development of the company.”
Elements to consider include expense history, product revenues, and the strength of the management team; the absence of any of these factors increases the risk of the venture's failure. Each successive stage increases the valuation. As milestones are reached, risk is reduced and subsequent rounds of financing can usually be raised at higher valuations.
Stage I: Ventures have no product revenues to date and little or no expense history, usually indicating an incomplete team with an idea, plan and possibly some initial product development.
Stage II: Ventures still have no product revenues, but some expense history suggesting product development is underway.
Stage III: Ventures show product revenues, but they are still operating at a loss.
Stage IV: Companies have product revenues and are operating profitably.1
Another consideration from the investor's perspective is pricing the VC deal. This involves estimating future values of the company being financed and is subjective. Estimating the future value is based upon estimated earnings multiples and expected profitability. The corresponding percentage ownership the investor requires can then be calculated as can the desired return on investment.
The nature of the business for the venture capitalist is taking higher risks with the expectation of higher rewards. Research and analysis is key in the evaluation process. As noted, there is both science and art involved. Risks and potential failure are part of the game, but nevertheless venture capital in Connecticut is breaking records.
As Marco says, “Linking investors with companies is an inexact science. There is no cookbook way of meeting investors. Nothing takes the place of hard work.”
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