Some Observations on Venture Funding

I have been travelling a bit, speaking to a number of different people across a lot of different sectors.  Thought I would put down some of the discussions I have had in relation to the venture and financing sectors at the moment.

The Bad

In general it seems to be tough in the venture market at the moment.  LP’s are pulling some of the funds they have under VC management.  This is having a number of effects. 

• Firstly, VC’s aren’t really looking at seed funding.  Instead they are focusing on using the funds they have to invest in subsequent rounds in their existing holdings.  Those who are still doing seed funding are looking for large stakes, 50% or more.  That is a lot to give up in round 1.
• Secondly because of the LP pull backs many VC funded companies that are up and running and even producing revenues have had their funds cut early.  This is causing problems as revenues are typically < costs so they are caught short and paying bills becomes a problem.  So, many revenue producing software companies are seeking early exists due to the disappearance of investment funds.
• Because the economy is bad, many of the exit points for these companies are no longer viable.  The exit points that rely on raising debt or external funding to acquire are finding it much together to do so.
• Those exit points with large cash reserves (a handful or large software companies) are on a mini buying spree.  They are picking up viable, revenue producing software businesses.  And they are doing it cheap, often below 1x revenues (maybe as low as .5x revenue).
• The founders of these businesses who get caught short because of the funding pull are often ending up with very little if not nothing at all.

The Good

Things appear to be improving.  The mood in the US and Australia is better today than it was at the start of the year.

• Funding is still around but it is harder to get it and you will have to jump through more hoops.
• VC funding is a special class of funding that should only be considered in special circumstances.  These include 1) when rapid time to market is critical, 2) when you need to run for a long period of time before starting to generate revenue (there are others).  But in all cases you should only consider VC funding if you have a model which has a practical path to substantial return on investment within a 5 year timeframe.  HINT: most “software” start ups don’t qualify for this.
• Starting companies that follow a more traditional path to revenue and eventual profits should use a more traditional set of funding mechanisms to achieve this.  That is self funding, angel investors or private equity. 
• In all cases you will be in a better position to receive funding on better terms if you have something real to market and you are producing revenues.
• Getting funding to acquire, do a management buyout, or spin off an existing technology may get you more air time with investors currently than proposing your build something from scratch.  Of course success here comes down how well you convince the investors of your ability to add value to that technology and why this hasn’t happened to date.

I am sure I have forgotten a few things in which case I will post them as updates to this post later.