Venture Capital Funding Slips, Slowing Business Development

By Zachary A. Goldfarb
Washington Post Staff Writer
Monday, July 28, 2008

It is going to be an adventure for venture capital -- that's for sure.

Locally, the National Venture Capital Association said this month that disclosed second-quarter venture capital investment slid 15 percent from the same period of 2007, to $234 million.

Funding fluctuates from year to year, but this was only the latest piece of bad news that has venture capitalists and start-ups concerned about a pernicious chain reaction: The overall financial downturn is making it nearly impossible for venture-backed firms to go public and difficult for them to be bought at prices they consider fair. That is forcing venture capitalists to pony up more cash to keep the companies in their portfolio afloat. And as a result, they have less money to back even newer companies with new ideas.

"It's really a question of staying the course and surviving," said Roger Novak, general partner of Novak Biddle Venture Partners in Bethesda. "This is the worst we've seen."

It is taking an average of 8.6 years for a venture-backed company to go public, compared with four years a decade ago, and venture capitalists think that's unlikely to improve soon.

Novak is also concerned that investments venture capitalists have made in Web 2.0 companies -- all the rage recently -- could turn out to be unsuccessful. He said the companies still are struggling to come up with workable advertising models to support their businesses, and venture capitalists may grow hesitant to plow more money into them.

Companies are still getting funded. In the most recent quarter, Avalere Health, a District company that consults on health-care strategy, received more than any other firm on the list of local disclosed venture activity: $19.95 million. On its trail was Competitive Power Ventures, a Silver Spring energy finance company, which received $19.5 million.

Other recipients included McLean online widget company Clearspring ($19 million), Vienna customer service software firm Parature ($17.2 million), Columbia sports media firm Digital Sports ($3 million), and tiny Woodbridge biometrics company ArtiNNet, which received $10,000.

The National Venture Capital Association study, which was based on Thomson Reuters data and done in partnership with PricewaterhouseCoopers, reported that nationally, $7.4 billion was invested in start-ups in the second quarter, about the same amount as a year ago.

Mark Heesen, president of the National Venture Capital Association, predicted in the organization's report that the industry would withstand challenges.

"The venture industry is operating under the same long-term philosophy it has adhered to historically. Venture firms are prepared to invest for 5 to 10 years and will stick with their companies through difficult times," he said.

Don Rainey of Grotech Ventures said small technology companies still have access to funding because they are far removed from the complex debt-based securities that have roiled the markets.

"My sense is we're in a fairly steady state," he said. Indeed, Grotech, in partnership with AOL founder Steve Case and his wife, took part in one of the more high-profile venture capital investments of the quarter: $5 million in LivingSocial of Georgetown.

LivingSocial, formerly known as Hungry Machine, builds applications that allow people to share, discuss and explore their likes and dislikes on profile pages on social-networking giants such as Facebook and MySpace. LivingSocial currently has applications for six areas -- books, music, movies, restaurants, games and beers -- that build on more basic tools the sites provide.

LivingSocial makes money in a few ways. If someone clicks on a friend's recommendation to buy a book, it takes a cut. It also integrates ads into the applications -- recently, for instance, promoting a Sony movie through its book recommendation widget.

"They are succeeding by monetizing the social network in a variety of ways rather than a single way," Rainey said.

Last week, LivingSocial launched a Web portal, allowing users to search through thousands of recommendations by their friends and other users.

Tim O'Shaughnessy, a 2004 Georgetown University graduate and one of the founders of the company, said the site gives people a one-stop shop for exploring their friends' interests.

"There's very much the social discovery aspect and browsing everybody else's collection," he said.

Asked about whether Web 2.0 companies can effectively turn their millions of users into dollars, he said that traditional strategies, such as placing display ads around content, may not work.

"It's going to be a little more integrated advertising campaigns, building add-on functionality that's sponsored by somebody or really kind of integrating their brand into the product experience," he said.

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