Seize the Dip: Downturn Offers Ripe Conditions for a Start-Up

With venture capitalists keeping a tight grip on their purse strings, starting a company may not seem the savviest move nowadays.

By:
Janet Whitman
Wall Street Journal

But while capital is scarce and returns on venture investments have never been poorer, the track record from previous downturns suggests that
conditions for building a solid start-up may be the best they have been in years.

The theory is that only the strongest companies, with genuine business plans and disciplined managers who know how to make money last, will
thrive in a tough environment.

"Historically, the companies that got off the ground during market slumps, [that] had difficulty raising capital, and grew step-by-step in the early
stages have been the ones to succeed," says Stephen Davis, an attorney with Heller Ehrman White & McAuliffe LLP.

Former fledglings like Apple Computer, Inc., Dell Computer Corp, Microsoft Corp., Oracle Corp., and Sun MicrosystemsInc. all were launched
during lean periods for venture-capital investing, notes Mr. Davis, who co-chairs the New York law firm’s emerging companies practice. "These
aren’t companies that were founded with a first-round $80 million investment," he adds.

Michael Dell, for instance, started selling computers from his college dorm room in Texas back in 1984, eventually dropping out and, with
$1,000 of his own money, launched Dell Computer. Even if Mr. Dell had known at the time about the existence of venture capital — he didn’t —
he probably wouldn’t have had much luck persuading venture capitalists to back him. His company, which revolutionized the way computers
were sold, was founded around the time an investment binge in personal computers and disk-drive companies was about to send venture
investing into a seven-year slump.

With the burst of the tech bubble, venture money is once again hard to come by. That’s a marked change from the late 1990s boom when
record amounts of venture capital were pumped into businesses that ultimately may never be able support themselves. In the aftermath of that
investing frenzy, VCs are preoccupied with salvaging what they can from their portfolios and are much pickier about new investments.

Extending a two-year decline, money invested by venture capitalists fell to $6.2 billion in the first quarter of this year, a 23% drop from the fourth
quarter of 2001, the most recent data from Venture Economics, the National Venture Capital Association and PricewaterhouseCoopers show.

The question, however, is what will happen with the roughly $95 billion in dry powder venture capitalists have waiting to put to work?

Many venture capital veterans and industry observers believe the next crop of start-ups won’t see much of that uninvested capital. "A lot of that
money will never come off the sidelines," says Peter Yunich, managing director of Metropolitan Venture Partners. A number of VC funds
already have returned some univested capital to their investors and that trend is likely to continue as returns sink further into the red.

Also keeping money out of the hands of fledgling companies is that venture capitalists prefer to invest in more established companies these
days.

During these lean times, the challenge for entrepreneurs and venture capitalists is to identify the next business or technology that will transform
an industry as Starbucks did for coffee and Microsoft did for computers.

Wireless technology could be the next launching pad, says Graham Watson, a managing director at Deloitte & Touche Corporate Finance. "It’s
been much maligned and suffered badly, but wireless infrastructure is one platform out there that could be a catalyst for a really significant
business opportunity," he says. "Mention wireless or telecom today, and everyone runs a mile. That’s a legacy of the overinvestment from two
years ago. But wireless is something that has massive appeal to individuals and corporations. There’s still a huge scope to grow the wireless
industry."

Although conditions may be ripe for launching a solid company, that doesn’t necessarily mean the venture-capital industry will reap the benefits.

They may miss out on the next big wave, just as they did on bootstrap companies like Dell, which received no venture funding, and Microsoft,
which had only a small venture investment.