April 1, 2002 Quarterly Stock Market Review --- Venture Capitalists Slowly Begin to Get Back to Business --- Investors Start to Look At Lots of New Deals, But Remain Cautious By Lisa Bransten Staff Reporter of The Wall Street Journal SIGNS ARE EMERGING that, after a long drought, venture investors are starting to put money into new companies again. But it also remains clear that nothing is back to normal. The evidence is anecdotal, since data about first-quarter venture investing won't be available until May. "I am hearing that people are back investing," says Mark Heesen, president of the National Venture Capital Association, an Arlington, Va., trade group. "They have put their toes back in the water, and many of them are very happy with what they are seeing right now." As overall funding tumbled last year, money going into brand-new start-ups fell even harder as venture capitalists spent much of their time and money helping existing companies get follow-on rounds of financing. By the fourth quarter only 15% of venture money went to companies raising their first institutional round of financing, and those companies accounted for only 21% of all companies raising money, according to data from the NVCA, PricewaterhouseCoopers and Venture Economics. That was a significant fall from 1999 and 2000 when new companies took in 23% to 31% of money raised and accounted for 35% to 45% of new deals. In fact, last year marks the first time since the early 1990s that new companies accounted for less than 30% of all venture deals. While most expect some recovery this year in the number of new deals, it is hard to say whether there will be enough activity to push the number back up over 30%, especially in the first quarter. That's in part because while venture capitalists are looking at lots more new deals, they remain cautious. Still, some investors are braving the risks to get in early at new companies. For example, the past quarter saw several relatively massive infusions for new companies -- often called A-round financings -- such as Woodside Networks Inc. and Cedar Point Communications Inc., which raised $20 million and $19 million, respectively. Todd Dagres, a general partner at Battery Ventures in Wellesley, Mass., which put some of the money into Cedar Point, says the deal was the first new one he had done in more than a year. "I stopped [making new investments] a year ago because you had to take care of the portfolio," he says. "You had to make sure your companies were in a survivable mode." And even though both Cedar Point and Woodside were classified as A-round deals, neither fits the traditional profile of an early venture investment. By one venture rule of thumb, companies get about three rounds of financing, an A-round to fund product design and development, a B-round to fund producing and selling a product on a small scale, and a C-round to expand sales and get to profitability. But Woodside is hardly just a couple of entrepreneurs and a business plan. The Palo Alto, Calif., company, which is making semiconductors that will help computers and other devices connect to wireless data networks, was founded back in January last year. It raised an initial $8 million from the founders and some tiny venture firms and expects to have product ready for commercial delivery later this year. Cedar Point, which was founded in September, had been funded on $5 million in debt and equity financing from the founders and some other investors. The Derry, N.H., company, which is developing a switching device that allows cable television operators to provide telephone service to consumers, is already in trials with its first product and, like Woodside, is expecting to begin sales by the end of this year. Battery Ventures is moving pretty slowly back into investing in new companies. After investing in only one new company a quarter in 2001, the firm did two new deals last quarter. That's still a far cry from the seven new companies the firm invested in during the third quarter of 2000. While the number of new deals this quarter remains low at Foundation Capital, activity is brisk, says Mike Schuh, a general partner at the Menlo Park, Calif., company. Foundation made only one new investment in the first quarter, but already has several offers out and has been looking more actively at new deals. He says the firm seems on track to invest in its general average of 15 or so new deals this year, up from nine deals in 2001 and 13 in 2000. Mr. Schuh says Foundation is looking mostly at more traditional new deals that have low valuations and need pretty small amounts of cash for starters. The environment for doing such deals is improving, he says, because entrepreneurs seem to have faced reality and are realizing that investors are no longer willing to pay big money for little stakes in companies. Also, he says, there seem to be more entrepreneurs around who are ready once again to go out and start companies. "We're now at a point where people who are entrepreneurially inclined are now willing to start companies," says Jon Feiber, a general partner at Mohr Davidow Ventures of Menlo Park, Calif. "Twelve or 14 months ago it was so unstable" that few were willing to try new things, he says, but now "nobody argues that technology is going to continue to free fall." One possible reason for the increased activity is that many venture capitalists are sitting on huge war chests and -- after a very slow period last year -- may be feeling some pressure to put some of that money to work. Mohr Davidow is one of the few firms that actually reduced its fund size to relieve some of that pressure, but others are no doubt feeling it, says Colin Blaydon, a professor at the Tuck School of Business at Dartmouth College who specializes in venture finance. "They are definitely feeling the pressure, and that is helping to up the [number of] deals that are getting done," he says. But he adds that caution probably still rules the day. "No one is doing things that they can't justify just because of the pressure."