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Venture capitalists seek moonshots, find lame horses

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CIOL Bureau
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Dane Hamilton

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NEW YORK: A few years ago, venture capitalists used metaphors like moonshots

and bulletproof to describe business plans of their favored investments. Now,

the talk has shifted to starving rats and lame horses.

"We're trying to shoot our lame horses quickly," said Paul Schmitt,

managing director PA Early Stage, a venture capital firm in Wayne. "In the

third and fourth quarters, a lot of companies will go out of business" as

venture capitalists cut funding for new enterprises, Schmitt told reporters at a

venture capital breakfast meeting sponsored by Red Herring, the

technology magazine.

"VCs are starving the rats and feeding the winners," agreed

Deutsche Bank co-head of global investment banking, Alex Bill Burgess.

"Clearly the bad news is not over yet."

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The bleak assessments come amid an ongoing slump in Nasdaq, a constipated

market for initial public offerings and a seemingly endless spate of profit

warnings by former Wall Street tech darlings like Lucent Technologies, Palm,

Cisco Systems, Dell Computer Corp. and others. In last year's second quarter,

225 companies pre-released mostly negative profit warnings, a number that grew

to 507 companies in the fourth quarter of 2000, according to Deutsche Bank.

As the value of public companies drops, private company valuations dry up as

market prospects deteriorate, thwarting plans for venture investors to profit

from initial public offerings. The IPO market has all but dried up, with 18

companies raising $7.2 billion so far this year, with the bulk of that - $5.6

billion - raised by Lucent spin-off Agere and global consulting firm KPMG. That

compares with 135 deals in last year's first quarter, when $24 billion was

raised, according to Deutsche Bank.

Now, early investors are demanding a quicker path to profitability as they

look to shoot holes through business plans for companies more desperate than

ever for cash. And they're demanding it for less investment. "It's more

like vulture investing than venture investing these days," said Tom Kuhn,

director of Allen & Co., a New York venture capital firm.

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This year's slowdown comes at a time when venture capitalists are awash in

cash, both from gains in their investments and from institutional investors

looking for the hefty returns of 35 per cent and up that venture firms generated

during the late 1990s bull market.

Venture capitalists raised some $92 billion in 2000, up from $60 billion in

1999 and from $8 billion in 1994, according to Venture Economics and the

National Venture Capital Association.

Now that public investment in Internet and technology stocks has slumped, a

few of the 700-plus venture funds may be returning money to investors, finding a

dearth of companies with solid technology that may appeal to the market. Burgess

said about 190 of the venture firms were founded in the last three years with

money recycled from the bull market during those years.

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The market has left venture capitalists searching for the Next Big Thing in

software, wireless communications and optical networking and broadband

components, or even farther afield into agriculture and health technologies. But

few claim to have found the next Microsoft, Intel or Cisco Systems, those

technology giants that drove the 1990s bull market.

PA Early Stage, for instance, is looking at companies like PlantGenix, which

engineers plants to make useful products like nylon substitutes or chemicals.

But such investments must be with seasoned management teams that have solid

business plans, says PA's Schmitt.

"We like entrepreneurs that have been through train wrecks," said

Schmitt. "They're easier to deal with. There's a lot less arrogance out

there now." Still, demand for technology spawned by Silicon Valley

continues unabated, ensuring a bright future for existing technology companies,

albeit with reduced expectations, reckons Red Herring Chairman Tony Perkins.

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Perkins said the 200 million people that now use the Internet will likely

grow to 2 billion by 2005, and that business-to-business e-commerce could grow

from the $131 billion in revenue in 2000 to $3 trillion in 2004. Not everyone is

as optimistic, but it's not dampening his spirits.

"A lot of venture capitalists are still hiding under their desks,"

Perkins told reporters. But, he said, "We're back in a more optimistic

mood."

(C) Reuters Limited 2001.

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