Start-ups and VC cash - life goes on

Venture capital is no longer a dirty phrase. The sector is getting back to normal after the madness of the internet bubble and that can only be good news for the tech industry, says Ben King.

The news in January that the Barksdale Group, set up by former Netscape CEO Jim Barksdale in 1999, would close its offices and raise no more money marked the passing of an era.

No company epitomised the days of internet madness quite as much as Netscape, except perhaps the spectacular grocery flop Webvan, which bought out the Barksdale Group's own food retailer play HomeGrocer in 2000.

So with the passing of the ex-Netscape CEO's venture fund, it seemed, another symbol of the spirit of entrepreneurship and technological innovation had slipped below the waters.

Luckily, the situation is not as bad as it initially may have looked. The crazy days of 1999 are long gone, to be sure, and the venture capital industry has taken a beating. But in the US and the UK, the downward graphs of confidence and investment seem at least to have touched the bottom.

Or at least that's what the survey data seem to be saying. Deloitte and Touche, for example, conducted a survey of confidence in the UK venture capital industry and it found the first significant rise in confidence among VC groups for almost three years - 92 per cent of the 770 private equity companies surveyed felt that things could only get better.

In the US, things are actually getting better. The PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree survey recently found the last quarter of 2001 was the first since the third quarter of the previous year to see a rise in investments.

These results haven't exactly been greeted as a triumph, more as recognition that the freefall is over and the industry can get back to business as usual.

However, the figures naturally look worse because they're compared to the wild boom years of 1999 and 2000. The total invested by the US venture capital industry over 2001 was $36.5bn (£25.4bn) - still ranked as the third best year ever - even though the technology industry itself was going through a year that's been widely described as the worst ever.

Many venture capital funds, including Barksdale's, are concentrating on reinvesting in their existing businesses rather than looking for new companies to add to their portfolios. This is partly because the current market makes it very unattractive to sell those businesses. But there is also money around for the funding of new and emerging ventures.

The big difference between now and the boom years is that people are no longer investing in ecommerce and internet retailing start-ups. This is hardly surprising. Retail is not normally a sector that gets venture capitalists enormously excited.

On the other hand, biotechnology and nanotechnology are both being cited as hot sectors by a number of venture capitalists. Despite the widely publicised problems of the mobile phone industry, there is still money for wireless start-ups and mobile infrastructure systems.

There is also still money around for compelling plays in less glamorous parts of the tech industry, if the business plans stack up and the people behind the venture have the necessary experience.

In many ways, the venture capital industry is getting back to basics - examining business plans more thoroughly, checking out the credentials of the business managers more thoroughly (no more former models or fashion columnists, please), treating forecasts with a little more skepticism. The days when 'first mover advantage' was everything are gone. The sector is taking things more slowly now.

Business plans which involve completely redefining an entire industry are also gaining less credibility. So there'd be little credence for Jim Clark's classic 1996 pitch for Healtheon, his online health business, along the lines of: "The US health business is worth $1.4bn per year (£970m at today's exchange rates) so even if we take only one per cent of it, we're laughing."

Even the entrepreneurial might of Netscape founder Clark wouldn't be enough. They'd want more involvement from people who actually understand healthcare.

So the old fundamentals that make a business attractive to venture capitalists - few or no competitors, high barriers to entry and preferably a unique technology protected by patents - are coming back into fashion.

VCs are not so much interested in backing the next Microsoft or the next Intel - it's more about backing the people who can sell to the current Microsoft or Intel. In dot-com parlance, this was known as 'selling shovels in a gold rush' - a phrase that graced many PowerPoint presentations back in the day. The gold rush may be over now but it's still the most promising way to make money.

As US Lawyer Jay S. Rand, who works for VC law with Morrison Foerster, says: "We're seeing a lot of wireless companies now that are saying: 'We're not sure that 3G is going to work. But we know that those companies are going to spend a lot of money trying to make it happen and that's who we're selling to'."

The brief period when starting up a VC-funded technology company seemed more exciting than starting a rock and roll band is sadly over. But the spirit of entrepreneurialism lives on and is all the stronger for the sobering-up period of the past 18 months.

Start-ups are as old as the high-tech industry itself. Individuals with good ideas head out on their own to make their millions and invent entirely new markets. Could HP or Microsoft, Intel or Oracle have had the success they do in any other way?

It's widely recognised that new ideas have a better chance of developing at a small company than a large one. They're better at taking risks, they're more focused, they don't have existing businesses to defend and they're more likely to be able to escape received ways of thinking about problems. And there are more of them about, so even if a large proportion don't make it, the chances are that one or two of them will.

So just as technology depends on innovation, innovation depends on start-ups. To see the VC industry coming back to life is an encouraging sign that the technology sector itself still has a strong pulse.