O Venture Capitalists, Where Are Thou?
By Carlo Longino, Mon May 21 00:00:00 GMT 2001

The party is just beginning.

Stock-market doldrums, declining revenues and layoffs are harbingers of doom for start-ups. Tech and high-tech companies’ inability to shake off their funk has put the brakes on many entrepreneurs’ wide-eyed dreams of IPO riches. But for wireless start-ups, things may not be so bad.

Many venture capitalists’ immediate concern is the protection of their previous investments – after all, a company has to survive to its IPO for them to cash in. Accordingly, they’re spending much of their time offering guidance to already-funded companies and arranging follow-on funding rather than looking for new investments.

And although the mobile world may have slowed down, it certainly hasn’t stopped. As carriers continue in their race for bigger, faster, and better services, the need for innovation and new technologies has not dried up. So savvy VCs, although not as free-spending as before today’s slowdown, are still investing in promising ideas like wireless.

"Innovation doesn't stop just because the stock market dips," Morgenthaler Ventures general partner Gary Little told USA Today.

Down, but not out

"The money has definitely not dried up," says Nirav Agrawal of a stealth-mode Bluetooth start-up. He says that VCs are still interested in emerging technologies like Bluetooth and mobility and are looking to get in on the ground floor. But he says the money that’s out there is coming with lots of strings attached.

Certainly investment is off. Thomson Financial says first-quarter European private equity investment was down 60% from the fourth quarter of 2000, and PriceWaterhouseCoopers says US venture capital investment was down 40% in the same time period. More importantly for companies looking for cash is that along with global equity markets, company valuations have tumbled.

What this means is that the old sweat equity system has come back in to play, and power has swung back into the hands of venture capitalists and away from startups. Twelve or 18 months ago, money was being thrown at any and every MBA grad with a business plan containing the word 'Internet.' Start-ups were being funded at sky-high valuations, and entrepreneurs really held the upper hand in any negotiations, knowing they could shop around until they found a VC willing to give them funding and meet their terms.

But as the money flow has tightened, so have the proverbial reins. "The power really rests with the venture capitalists now," Agrawal says. "It’s shifted back from the start-ups. The venture capitalists are asking for huge stakes of the company at incredibly low valuations."

Agrawal says his company decided to pursue other avenues of funding after venture firms were asking for a larger chunk of the company than they were willing to give up. "We could have raised USD 4 to 5 million – which is nothing compared to what we could have raised a year ago – fairly easily. But we would have had to give up 80% of the company, which was something we weren’t willing to do."

The company instead went to private investors – often friends, family, or business contacts – to raise smaller amounts of cash to get the company off the ground and build a more stable side of the business, an India-based IT services consultancy. "We figured by starting this aspect of the business first, we can bring in revenue and in a way incubate the Bluetooth and wireless development ourselves." So much like the artist who slaves away at a paying job during the day to support his creative endeavors at night, Agrawal’s company hopes to make their 'real' work pay off for their Bluetooth business.

This little piggy goes to market

And getting that initial product developed may be enough to bring in later funding necessary to take the finished item to market.

"What we were finding was that the venture capitalists were looking for a finished prototype or beta product – or even better, a few trial customers - and then were interested in funding the final development and taking it to market," Agrawal says.

So Agrawal and his co-workers decided to forgo the furnished snack rooms, Aeron chairs and all the other trappings associated with well-funded startups and develop an initial product with as little outside money as possible for the next year, then revisit the VC scene. "We figure if we can’t add value in 12 months and get it right, we should get out," he says.

He is confident that with a beta product, the company will attract the additional funding it needs. "Just look at Red-M," he adds. "They showed they had a viable product, and raised a knockout second round."

Red-M, a British-based company that makes Bluetooth servers, announced in April it had raised a second funding round of USD 43 million. The company was started by UK networking company Madge Networks last May, and spent a year developing its products and technology, coming out at the end with a physical product ready for sale. By jumping to an early lead in the hot Bluetooth market, Red-M ensured itself access to capital to follow through on the execution of its business plan.

Beyond an actual product, Agrawal said VCs were also looking for seasoned management teams. "You’re not going to see too many more companies headed by recent MBA grads or teenagers getting huge sums of money," he says. "They realize now that a 25-year-old whose only experience comes from case studies isn’t nearly as valuable as a 45-year-old who has done all this before."

Go East, grasshopper

Geography may also play a large part in wireless companies’ hunt for venture money. Venture capitalists focusing on Asia may have mistaken the recent market slaughter for a speed bump rather than a wall as opportunities in the East continue to catch their fancy.

Japan’s decade-long economic slump has finally opened the Land of the Rising Sun to outside investment, piquing the interest of U.S. venture capitalists who previously found it difficult to break in to the country’s insular economy difficult. And Japanese companies’ newfound willingness to spin off promising projects rather than keep them under the umbrella of huge corporations isn’t hurting either.

Leading the pack are wireless start-ups, as Asia prepares for the world’s first 3G networks. "We think 3G wireless is going to be a big, huge thing," says Ta-Lin Hsu, the head of H&Q Asia Pacific. His most recent fund is investing in application and platform developers, as well as content producers and hardware component manufacturers.

For instance, H&Q Asia two years ago bought Japan’s number-two cable music station from giant Pioneer for a paltry USD 50 million. They then turned the channel into MTV Japan, which plans to offer downloadable videos via NTT DoCoMo’s i-Mode service by the end of the year.

Silicon Valley powerhouse Draper Fisher Jurvetson also recently said it plans to invest between USD 100 million and USD 1 billion in Asia over the next decade, with an emphasis on wireless. "I believe this is the place I should be putting the most dollars I possibly can," said DFJ Managing Director Tim Jurvetson. “The wireless space is completely wide open."

Ample opportunity ahead

So while the world’s equity markets choke on the failures of ill-thought-out dot bombs, wireless ventures have certainly not been cut off from capital, although what they can get won’t come easily and will definitely come at a low valuation.

And although the game may not be as immediately rewarding in the financial sense as it was a year ago, the technological advancement of worldwide mobile networks towards 3G means that carriers will be looking for new innovations to drive their revenues, providing entrepreneurs ample opportunities to cash in on the mobile future.

Carlo Longino is a freelance writer based in Austin, Texas, where the weather is much nicer than Helsinki. In addition to writing for TheFeature, his previous experience includes work for The Wall Street Journal, Dow Jones Newswires and Hoover's Online.