Green is where it’s at
If you want venture capital this year, it would be wise to consider going into clean technology. “The area that is growing most is clean technology, which includes alternative energies like solar, wind, biofuels; conservation companies; even companies extending life of batteries,” said Emily Mendell, vice president of strategic affairs at the National Venture Capital Association (NVCA) in Arlington, Va. The NVCA is an advocacy group for entrepreneurs and innovators whose members consist of approximately 450 venture capital firms in the US.
Venture capital investments were down overall in 2008, marking the first yearly decline since 2003, according to the 2008 “MoneyTree” report, produced by Price-waterhouseCoopers LLP and the NVCA based on data from Thomson Reuters. The $28.3 billion invested in 3808 deals represents an 8 percent decrease in dollars and a 4 percent decrease in total deals from 2007. Fourth-quarter investments in 2008 totaled $5.4 billion, which is the least amount of dollars invested since the first quarter of 2005; it’s also 26 percent less than the $7.3 billion invested in 2008’s third quarter.
The 2008 fourth-quarter investment drop affected sectors nearly across the board, from life sciences to software to Internet companies to media and entertainment – most saw percentage declines in the double digits for both dollars and deals.
“At this point, venture capitalists are doing what everyone else is doing: assessing and reassessing their capital outlays and each and every investment carefully in order to make prudent decisions on what companies have the brightest outlook for the long term,” said Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers.
Life sciences, with 28 percent of all investments, saw investing dip 15 percent, down to $8 billion from $9.3 billion in 2007. However, the number of deals dropped only 3 percent, from 883 in 2007 to 853 in 2008.
“Well, no one is necessarily immune to the recession,” Mendell said. “The most direct impact that the recession has had on venture capital is what we call the exit market.”
When a venture capitalism firm puts money into a project, she explained, it funds that project for five to 10 years; after that, the company exits onto the public exchange or through acquisition by another company. But the current economy has created fewer opportunities in the exit market.
“Now, many companies aren’t able to get out of their (investment) portfolios,” she said. “That’s the most immediate impact.
“Venture capitalists are still investing, but there’s pressure to invest at a somewhat slower pace.”
Green-powered growth
In spite of all this, investments in clean technology grew more than 50 percent last year.
“That area is growing exponentially, despite the recession,” Mendell said. “For instance, in 2008 venture capital firms put about $4.1 billion into clean-tech companies – that’s up from $2.7 billion in 2007.” Indeed, seven of the ten largest deals of 2008 took place in the clean-tech sector.
Clean, or green, appears to be where it’s at. “Clean tech is an area that’s been hot for a little while,” said Mike Dauber, a senior associate in the Menlo Park, Calif., office of Boston-based Battery Ventures. The firm invests venture capital in Internet and digital media, financial services and tech-enabled businesses; software; semiconductors and components; infrastructure technologies; and communication services. “We’re careful in [the clean-tech] space, too,” Dauber noted, “but it’s certainly a market that’s going to have potential going forward.”
There are a number of reasons why investors are excited about clean technology, Mendell said. “For one thing, the government recognizes how important it is to move these technologies forward – the government is very supportive of these technologies. And consumers are ready to adapt to new behaviors, new products.
“It’s a perfect storm of innovation in these areas. And that’s what venture capitalists do: take innovation and bring it to market.”
But where do venture capitalists get the capital to bring innovation to market? Whose money are they using?
“A lot of people get this wrong,” Mendell noted. “Venture capitalists invest money from large institutional players like pension funds, endowments and so on. They take some individual money, but only on a large scale. A mom-and-pop operation, or you or me – we can’t put our money in.” But, she added, it’s possible for the regular Joe to invest in venture capitalism through a pension fund, for example.
There are various ways for fledgling companies to find venture capitalists to fund their projects, she said: “The Internet is a very powerful tool. You can find venture capital firms and submit business plans online today. Google ‘venture capital,’ Google your industry.” The NVCA even has an online directory of venture capitalists at www.nvca.org.
“It’s good to talk to other entrepreneurs in your region – people working in innovative areas tend to know each other,” Mendell said. Word of mouth helps direct the search, and references from other entrepreneurs in your region or your industry can narrow down a list of potential investors.
At Battery Ventures, new companies are found in all kinds of ways. “Anything from someone looking us up on a Web site to a friend of a friend,” Dauber said. “We also go to trade shows, meet with entrepreneurs – you talk to friends of yours, and you find out who’s looking for funding, who’s starting companies. “It’s interesting how, once you enter the VC (venture capitalism) community, people tend to find you.”
He cautioned that venture capital firms need entrepreneurs to do their homework before pitching their ideas. “You always want to understand someone’s business model,” he said. “Often you get the business plan, and you walk through: Here’s the team, here’s the technology, here’s the market we’re going after, here’s how we differentiate ourselves.”
But Battery has been known to help people start companies from the very beginning, too, helping them to fine-tune their ideas. With Redwood Systems of Fremont, Calif., “we were working side-by-side with the CEO – pre-ground floor,” Dauber said. Redwood makes energy-control systems for green buildings.
And if you’re just starting out, there’s good news: The “MoneyTree” report pointed out that seed-stage investments grew to $1.5 billion into 440 companies in 2008, a 19 percent jump from the $1.3 billion funneled into 450 companies in 2007. “Seed stage” refers to a company’s starting point, when founders create a business plan and work on prototype development and testing. The $1.5 billion amount is the largest investment in seed-stage companies since 2000. Later-stage and expansion-stage investments saw declines.
“The stability of seed- and early-stage deals as a percentage of total deal volume suggests that venture capitalists are continuing to fund very young companies,” said Mark Heesen, president of NVCA, “giving credence to the philosophy that an economic downturn is a time ripe with opportunity.”
Mendell expects the coming year to be challenging, but she isn’t pessimistic. “I think it’s going to be tough on everyone,” she said, adding that a number of venture capital firms could go out of business this year.
Dauber’s advice for new entrepreneurs is to keep a level perspective. “You certainly have to have the stomach for it,” he said. “I think for any entrepreneur, you have to be prepared for a certain level of rejection. You can’t take it personally; people are being very, very cautious.
“As you’re constructing your business plan, it’s also important to think about how the investors are going to make money. This will help you both in your interactions with VCs and in determining how much money you can raise. ”
And enthusiasm doesn’t hurt. “You need to have an idea and market it so people are excited about it,” Dauber said. “If the entrepreneur isn’t excited about the project, they can’t expect the VC to be.
“All it takes is one great team and one great idea, and you can make a good company out of it.”