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Crisis Mode: Less Ventured
Investors Stick With Start-Ups They Know

By Kim Hart
Monday, October 27, 2008

For many local tech companies, it's feeling a lot like 2000 all over again. The Nasdaq is down, funding has dried up and entrepreneurs are hunkering down for a long winter.

It's not that venture capitalists aren't busy -- they're busier than ever. But they're spending less time investing in new deals and more time focusing on the start-ups they've already made big bets on and coaching companies to conserve cash.

"VCs have to be very careful and realistic, and entrepreneurs have to understand that getting that next round of financing is not automatic," said Mark G. Heesen, president of the National Venture Capital Association, based in Arlington.

Two sets of data on venture capital investments released this month showed a drop in dollars in the third quarter, and industry veterans expect the trend to last well into 2009.

In the Washington area, $189 million was raised in 45 venture-capital deals, a 13 percent decrease from the $217 million raised in 50 deals in the second quarter. Compared to the same period last year, third-quarter investments dropped by 46 percent, according to the MoneyTree Report on quarterly venture financing by PricewaterhouseCoopers and the NVCA.

Dow Jones VentureSource, which includes private-equity deals in its report, shows Washington area companies raised $264 million in venture capital during the third quarter, which was about 27 percent -- or nearly $100 million -- less than in the same period of 2007.

Nationally, venture-capital investment declined 7 percent to $7.1 billion, compared to $7.7 billion in the second quarter, according to the MoneyTree Report.

Local investors insist they're still open for business, but they have to be much more selective about funding new deals.

"We have the capital, we have the appetite, but we don't have the bandwidth," said Jack Biddle, general partner at Novak Biddle Venture Partners in Bethesda.

Venture-capital investors often become active advisers to start-ups receiving money, guiding the business as it grows. But the credit crisis has made it more difficult for start-ups to go public or be acquired by larger firms -- the main ways venture capitalists get their money back to make new deals.

So many investors are still tending to companies they had hoped would be on their own by now.

At Novak Biddle, for example, each partner is now an adviser to about 10 firms, twice as many as usual. The firm was among the most active during the quarter, participating in four deals, including a $10 million investment in Appian, a nine-year-old software firm.

"We're still looking for deals, but it has to be really cool, breakthrough stuff," Biddle said. "And we have to see that we can take a company to profitability for a reasonable amount of money."

That could bode well for young companies looking for smaller sums to help them get off the ground. Valhalla Partners of Vienna invested $400,000 in MiserWare, a Blacksburg start-up that has developed technology that controls the amount of power a computer server uses, to save electricity.

"There's been a lot of great companies created by early investments during economic downturns," said Gene Riechers, general partner at Valhalla. "What today's environment is like is not a predictor of what it will look like in one or two years when these companies come to market."

But first everyone must overcome their fears.

Jonathan Aberman, founder of Amplifier Ventures in McLean, which focuses on early-stage financing, said the current environment is creating much more anxiety among investors than the tech recession eight years ago. Results of a survey released last week by law firm DLA Piper showed that nearly half of the venture capitalists surveyed believe the current crisis will be worse than the tech crash of 2000.

Aberman's advice to entrepreneurs looking for a first round of funding: "Stay stealthy, hunker down, build your business and come out in the spring."

"Every investor is keeping an eye out for that one rock star deal that may come across their desk," said John F. Hurley, senior executive of the firm's Venture Pipeline group in Reston. "The problem is, the vast majority of what we see today is just another widget, and that's not going to be that home run."

Angel investor John May, founder of the New Vantage Group in Vienna, said angel investors are often most vulnerable to economic droughts. Many angels invest as a hobby because they have large amounts of disposable income. But, since their net worth is often tied up in stocks and real estate, many have taken serious hits this year.

"The good thing is, you can buy a lot more in today's market than you could a year ago," he said. "What we don't know is if in January, will things be so draconian that only those who break even can survive for another day?"

His advice to other angel investors: "Suck it up -- if we're gonna be important in the good times, we've gotta be important in the bad times."

Mark A. Frantz, general partner at Arlington-based RedShift Ventures, may have the most rosy view of the sector. He predicts the local tech community will fare better than other venture capital hubs such as Silicon Valley.

"The Valley is the epicenter of consumer trends, so there will be an impact from a drop in consumer purchases and online advertising," he said.

Washington, however, has a multibillion-dollar technology buyer called the federal government. And a number of local start-ups count agencies as customers.

"Maybe you don't build another destroyer; maybe you don't increase Medicare," he said. "But you're still going to buy security systems and evolve the technology used by various departments," he said.

State-funded investment groups are also feeling the pinch. The Maryland Technology Development Corp., or Tedco, invested in eight companies in the third quarter. But its state funding is also under pressure. This month, Maryland cut the organization's budget by $460,000, to $4.3 million.

"We've got to bleed a little like everyone else," said Renée Winsky, Tedco president and executive director.

Tom Weithman, who oversees investments of Virginia's Center for Innovative Technology, said he's used to doing more with less.

"As seed-stage investors, it's always about the burn rate for us," he said.

Kim Hart writes about the region's technology scene every other Monday.

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