Industries Banking/Finance

Venturing out

New companies are starting to find investors again

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Print this page by Doug Childers

A lot of us did some belt-tightening during the recent recession. Venture capitalists and angel investors were no exception. For many of them, preserving capital became a necessity, while others held back because they didn’t see good investment opportunities.

“Venture-capital firms and organized angel groups have been focused on funding their existing companies to keep them alive,” says Richard Crawford, a lecturer in small business finance at the University of Virginia’s law school.

Here’s the good news:  Recent activity suggests companies are likely to find investors returning to the deal table this year. Big deals in key fields, such as clean energy and social media, are already being made. The IT field is generating interest, too, because startup costs in Web-based businesses have declined.

Redefining patience 

Venture capitalists and angel investors always have faced risks. As part of their investment strategies, they provide money for startup companies too small to trade publicly and too risky to secure traditional loans, in some cases. (Investments from angels tend to be smaller than ones made by venture capital firms, which also have the capacity to fund later-stage companies.) In exchange, the venture capitalists and angel investors become part owners and turn a profit when the startup goes public or is bought by a larger company.

Waiting for a company to get strong enough to go public requires patience even in a good economy. The recession redefined patience by putting the brakes on initial public offerings, forcing investment firms “to hold onto new companies longer than expected, often investing extra rounds until the recession ended,” says Emily Mendell, vice president of strategic affairs for the Arlington-based National Venture Capital Association (NVCA).

No venture-backed companies in Virginia have gone public since 2007, when two companies — Herndon-based K12 Inc. and Reston-based comScore Inc. — did, according to the NVCA. “That’s par for the course, nationally,” Mendell says. (The association classifies the highly successful 2009 IPO of Arlington-based Rosetta Stone as a debt-related, private-equity deal.)

Nonetheless, the volume of venture-backed acquisitions — which account for the majority of venture-backed exits — rose to 427 last year after declining to 272 in 2009.

Acquisitions of venture-backed companies in Virginia rebounded as well in 2010, rising to 11 after falling a high of 15 in 2006 to five in 2009.
The number of new business startups declined during the recession. The Census Bureau said in March that 403,765 firms were started between March 2008 and March 2009, down 17.3 percent from the previous 12 months.

The recession hit venture capital firms hard. “One-year, end-to-end returns for 2008 and 2009 were negative, due mostly to the shuttered IPO market,” Mendell says. Nationally,  there were 791 U.S. venture capital firms last year, up slightly from 2009, but down from a high of 1,023 in 2006, according to the NVCA. Twenty-one firms with headquarters in Virginia made an investment in 2010, down from a high of 24 in 2005. (Virginia, which hit No. 2 on’s list of Best States for Business, ranked 11th in the U.S. with $375 million in capital investments in 2010, according to the NVCA.) 
Last year saw further contraction among venture capital firms, “and we expect them to continue to shrink,” Mendell says.

Two factors are driving that shrinkage, says Fred Russell, chairman of Richmond-based Virginia Capital Partners, whose portfolio of investments includes Virginia Business magazine. “The poor performance of the venture capital industry has contributed to a softening of investor demand for investing in venture capital funds” overall, Russell says. And the best-performing venture capital firms are attracting investors, leaving some that haven’t performed well without allocations.

The future of investing  

It’s not all bad news, though. “We’re seeing a number of entrepreneurs coming to us with an interest in being part of the next new wave of high-growth businesses,” says John May, managing partner of Vienna-based New Vantage Group, which organizes private equity for early-stage companies in the region. “It’s likely we’ll look back and say late last year was when businesses started to go out and seek capital and try to expand.”

Industry leaders expect those ventures to be received more favorably among investors, too. A survey conducted by the NVCA in late 2010 found that a majority of venture capitalists and venture-backed CEOs responding expect U.S. venture investment to increase this year.

“Big deals in key fields are already getting made,” Virginia Capital’s Russell says. “The market for clean energy and social media is really hot, and a lot of money is going into that — $30- to $50-million deals. That takes us back to the dot-com bubble.”

That kind of investment is out of the reach of angel investors, who typically participate in companies raising $500,000 to $2 million. (“That’s the sweet spot for groups of angel investors,” May says.)  Instead, many angel investors are focusing on IT companies (where startup costs have declined, particularly in Web-based businesses), as well as medical devices.

“A strong IT performance could put Virginia in a good place,” Mendell says. On the other hand, biotech “has the longest investment time for venture capital investors, and you need to have a tremendous amount of patience waiting for drugs to get through the approval process,” she adds. “Of the three major areas (clean energy, IT and biotech), it’s the most challenged.”

Regardless of the sector, though, the future is looking brighter. “Many investors —  both venture capitalists and angels —  have been keeping their tinder dry during these past few years,” says Sean Carr, director of Intellectual Capital at the University of Virginia’s Batten Institute.

“And it’s no wonder, since lucrative exits have been exceedingly hard to come by,” he adds. “But now — and this may sound counterintuitive — it seems that our recent economic challenges may have laid the foundation for a bold new wave of venture investing.” 

More: Could venture capital rescue impoverished areas?

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