The downturn in the U.S. economy and the aftermath of the Internet gold rush have venture capitalists (VCs) thinking twice before investing in entrepreneurial ventures. This means that entrepreneurs must be extra savvy when seeking capital.
Investments by VCs for the third quarter of 2002 totaled $4.5 billion, a decrease of 26% from the prior quarter, according to the PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree Survey. In the second quarter of 2002, venture capitalists invested $6 billion; only 647 companies received funding compared to 838 in the previous quarter. The last time quarterly venture capital investments went below $5 billion was during the first quarter of 1998, when investments totaled $4.2 billion.
The current state of the VC environment was discussed at the 32nd annual meeting of the National Association of Investment Companies (NAIC), held at the Omni Tucson National Golf Resort and Spa in Tucson, Arizona, in October. The NAIC is an industry association that promotes the development of finance and investment firms that invest in businesses with minority ownership. Its members, which include general partners, limited partners, and associates, manage more than $4 billion in assets.
So what can entrepreneurs do to increase their chances of securing a piece of what is still a multi-billion dollar pie? BLACK ENTERPRISE spoke to NAIC members, who shared valuable tips on the best way to approach venture capitalists during lean times. Here’s what they had to say.
Develop a flexible business model: Laurence C. Morse, chairman of the
NAIC and co-managing partner of Farmington, CT-based Fairview Capital Partners Inc., says that although venture capital spending has declined, companies must be able to adapt. “The nature of the business is up and down,” he says. In this unforgiving economic climate, his members’ companies are focusing on supplying capital across a number of industry platforms, including basic manufacturing, transportation, and the medical and health industries.Go back
to the basics: During the tech-happy boom of the late 1990s and 2000, the venture capital market moved away from fundamentals, hoping to strike it rich on dotcom companies with no cash flow measures in place and little regard for burn rates. However, in the current economic downturn, that’s no longer the case. “It’s critical for entrepreneurs to focus on the fundamentals — whatever it is in their business that drives revenues and profitability,” says Cedric J. Penix, executive vice president of Los Angeles-based Fulcrum Capital Group. “They have to show that they can manage costs and cash-burn rates, because those are critical now.”Assemble a strong management team: Penix says a flexible business model and the ability to monitor costs and cash flow are signs of a solid management team — criteria VCs look for before opening their wallets. When Penix considers an investment, he wants to know whether or not a management team can execute their plan. “Does the management team have the ability to identify fundamental changes in their business? And can they adjust to those changes and still maintain profitability?”
Be crystal clear: Before presenting a business proposal to financiers, Morse says, make sure that it includes a description of the product or service (and whether that product or service is complete or in development), the size of the product’s potential market, the percentage of the market the entrepreneur intends to capture, and the competition the product will face. Provide a time frame for securing the market and an idea of the financing required to realize the company’s business goal. And be clear about how the proceeds from the proposed financing will be used. A venture capitalist wants to be confident that the management team’s experience, skills, and track record make it a team that is likely to succeed.