What Shareholders Don’t Know About High-Tech Venture Capital

The process seems simple enough: You have an idea, youfind a venture capital firm willing to invest, and youput your plan into action.

In reality, the process is a lot more involved and has changed significantly since the dot-com glory days.

Appearances Deceive

In the late 1990s, venture capital firms played fast andloose with Web companies — and were involved in questionable practices that never reached the ears of shareholders.

“A lot tried for form over substance, and in makingthe books look good may have rendered the companynot viable long-term,” Giga InformationGroup Latest News about Giga Information Group Giga Information Group Web Site analyst Rob Enderle told the E-CommerceTimes. “That’s one of the reasons why theyhad so many failures.”

A few years ago, practically all a startup had to do to get funding was to mention the word “Internet” in a business plan. But once funded, many Web companies discovered they had a long way to go before reaching profitability.

According to Enderle, some venture capital companieswould come in and cut expenses very close to the boneto make a startup look better on paper. That way, they could guarantee a strong public offering and a nicereturn on their investment.

“Instead of making the company better, they focused on making it look better,” Enderle said.

Doomed To Fail

But the biggest thing investors do not know aboutventure capital-funded companies is their rate of failure.

“The average investor is blind to the rate of VC success. Thesuccess ratios are not necessarily that great,” DavidFurlonger, vice president and research director atGartnerG2 Latest News about GartnerG2 GartnerG2 Web Site, toldthe E-Commerce Times.

During the boom years, even when a VC made its money back on anew company, many dot-coms went belly-up when the venture capital firms pulled out after the IPO.

“It would look very bad for a venture capital firm todo a public offering and then to have the company turnaround and fail,” Enderle said.

But he noted that in fact this happened quite frequently — and while venture capital firms’ reputations may have suffered, they already had the money in their pockets.

The problem was so widespread when Internet companieswere hot that the failure rate for new dot-coms soaredto more than 80 percent. But Enderle saidthe problem has largely self-corrected.

“I don’t expect this problem to recur exceptoccasionally,” he said. “Anything more than a 10 to 20 percentfailure rate, and you’ve got a problem.”

Lingering Doubts

Doubts about the practices of venture capital firmsremain, however. “There is still a feeling that VCsremain arrogant in the face of more difficult economictimes,” Furlonger said.

“VCs were wrapped up in the Internet furor, and theylost sight of what they were there to do,” he added. “They thoughtthey could put money into any venture and make money.There was less attention paid to due diligence andperhaps making more sound investments.”

These days, venture capital companies are being much more carefulabout pouring money into Web companies.

“To go in and say, ‘I’m an Internet company,’ would cause hysterics in the aisles,” Enderle said. “The one thingthat would have made you golden a year-and-a-half agowill now brand you a loser.”

There is still money out there, but it is moredifficult to get.

“Now, you have to have a much betterargument just to get a meeting,” Enderle said. Andthese days, he added, venture capitalists are “second only tothe CIA” in the thoroughness of their vetting processes.

“Now, you almost have to show revenue, clients andproduct — it sounds odd, but that’s the way it is,”Furlonger said.

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