VC Funds Next to Fall

The aftershock from the financial market explosion will topple scores of venture capital firms this year and for years to come, according to industry executives, who also predict investment could fall 50 percent this year and the industry overall will have negative returns for 2001.

Even the stronger funds are investing less money in fewer companies, especially new businesses, and are stretching out their investments over two or three years. With some exceptions, telecommunications services and equipment suppliers, business-to-business companies, Internet service providers and consultancies are unlikely to find many willing investors.

In the first quarter, the number of companies receiving first-round funding fell by 50 percent to 327, from 656 last year, according to VentureWire, an industry newsletter on the Web. Total investments dropped 43 percent to $14.5 billion in 1,051 companies, from $27.7 billion invested in 1,855 companies in 2000s first quarter.

VentureWire predicted $47 billion will be invested this year, almost 57 percent below last years $108 billion. How much money will be raised by VCs is impossible to predict, but John Taylor, executive vice president at industry trade group the National Venture Capital Association, noted that $35 billion raised in 2000 has not been invested yet.

VCs that cannot show positive results or whose managers do not have strong ties to institutional or wealthy investors will lead the parade of dying VCs, said sources. Firms that cannot or will not pony up their share for later investment rounds to keep struggling portfolio companies alive could lose their entire first investments.

Vulnerable 20 Percent

"Probably 20 percent of the firms that raised a fund in the last two years wont be able to raise another fund, and will just go away by the end of this year," said Todd Dagres, managing partner at Battery Ventures, Cambridge.

That 20 percent failure rate could continue for several years as it did in the 1980s and 1970s when the stock markets also crashed, said Ken Andersen, managing editor at VentureWire Group. "You are beginning to see signs of it already."

He said Watershed Capital in Austin and Venture Frog in San Francisco are winding down their operations. The companies did not return calls requesting comment.

Blue Vector, a New York firm formed early in 2000, ran out of funds after investing everything last year, according to an industry source. MarchFirst took a 50 percent interest in Blue Vector in March 2000 and plans to sell that stake to Divine, the one-time Chicago incubator. Blue Vector also did not return calls for comment.

VCs that cannot raise a second fund typically merge with other firms, sell their portfolios and return what is left over to their investors, or just quietly wind down their businesses, while continuing to draw management fees.

"I cant believe all the e-mails I am getting from people looking to buy portfolios," said David Crockett, a founder of Aspen Ventures, which has raised three $50 million funds since 1991. Managers of firms that trade in portfolios said their pipelines have doubled or tripled in the last year.

Aspen still has money in its third fund and is looking at early-stage investments, he said. Finding other VCs to do second-round investing has been more difficult, Crockett said. He said he has even had to resort to calling VCs in the Midwest and on the East Coast because California VCs are so preoccupied with servicing their own portfolios.