Reversing decline, venture capital funding rebounds
Nationally, venture capital fund-raising increased sharply last year, reversing a three-year downturn — and there continue to be significant funding opportunities for late-stage as well as early- and seed-stage companies in 2005.
Dividing investments regionally, New England remains a strong second in total venture investments, second only to San Francisco Bay area companies. What do these trends mean and how can companies position themselves to take advantage of the funding opportunities?
Reversing the recent decline in total dollars invested and the number of companies receiving financing, venture capitalists in 2004 invested a total of $20.9 billion into 2,876 deals according to the PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree survey.
Leading the rebound was a significant increase in later-stage investments. Average funding per company also increased for later-stage investments by more than 20 percent over 2003. This increase was fueled by the strengthening IPO and acquisitions markets and, since later-stage investments are generally made in contemplation of a sale or IPO, suggests that exit opportunities will continue to strengthen in 2005.
Early- and seed-stage investments also increased in 2004, with 28 percent of all financings going to companies receiving financing for the first time. Now that investment firms are confident they have cleaned up the mess left when the stock market bubble burst four years ago, the cloud hovering over early- and seed-stage investments seems to have all but disappeared.
Venture capital firms raised $14.9 billion in 2004, up 50 percent over 2003 and the first such increase after two straight years of declines. In addition, at least 40 venture capital firms that raised money in 1999 and 2000 have not yet returned to raise a successor fund.
Typically, venture capital funds have a five-year investment period, so these funds would be expected to raise a successor fund in 2005 if they did not already do so at the end of 2004. Some undoubtedly will return to the market to raise successor funds, making additional capital available to make investments.
A company can take a number of strategic actions to best position itself to take advantage of these funding opportunities.
In a given year, the typical venture capital firm receives 10,000 qualified business plans, has 1,000 meetings, conducts 400 company visits and makes 10 to 20 new investments. Here are a few tips to help rise above the noise of competitors:
• Assemble the best management team possible. Venture capitalists look for companies with the strength and depth of management to achieve their targets. Key elements are relevant management and technology experience, a degree of entrepreneurial skills and a passion for winning. This is not to say that the entire management team needs to be in place from the start, but if it is not, management must be aware of the skill sets required and include this in their business plan.
• Have customer validation for your concept or product/service. Venture capitalists look for companies that offer “must have” rather than “nice to have” products or services.
• Differentiate yourself from the competition, and have a defendable IP/barrier to entry.
• Be persistent. Very few companies get funded by the first (or even the third) venture capital firm that they contact.
• Target the right venture capitalists. The investment criteria of most venture capitalists tend to be quite specific regarding things such as location of the business, industry sector, stage of the company, size of the investment, type of structure and level of ownership typically sought and level of involvement through board representation. In addition, entrepreneurs should target venture capitalists with a track record of success, who have expertise in the company’s area of focus, who are located in the same geographic region or have significant local contacts, who have contacts to partnering and customer relationships and who require an active role in the companies in which they invest.
The venture capital industry appears to have turned a corner, opening its doors to greater investment risks and more funding opportunities to companies at various stages of growth. Competition for financing remains fierce, but success is attainable if a company strategically and persistently targets venture capitalist firms and demonstrates a highly strategic business plan with a strong, knowledgeable management team to back it up.
John Beals, a partner in the Private Equity Team of Nixon Peabody LLP, is based in the firm’s Manchester office. He focuses his practice on assisting clients with corporate and business law matters, including private equity and venture capital investments.