Wall Street’s crisis has cast a pall over venture capitalists in Silicon Valley. But in the Tri-Counties, investors and start-ups alike say they’re prudent but undeterred.
“We’re not as exposed to the vagaries of the public markets,” said Frank Foster, managing director of the DFJ Frontier Fund in Santa Barbara, which has funded Santa Barbara firm Iconix. “The credit markets don’t really affect us as much. We like being investors who have a day-to-day, hands-on working relationship with their CEOs and their teams, especially in this time, in this environment.”
If anything, regional investors say, a few lean years in venture funding could produce some of the region’s next great start-ups.
“Valuation is typically more rational in these environments,” said Jeff Cohn, a venture consultant with MHS Capital and Tech Coast Angels, which has funded Santa Barbara firms EZ Assure and Make It Work.
Although 2001 and 2002 were tough years in technology, “Those would be what I’d call Tech Coast Angels’ vintage years,” Cohn said. “I’d largely attribute that to there not being a lot of money under management in Southern California. In a frothy environment, 10 companies get funded doing the same thing. In a down environment, one company will be funded.”
According to an Oct. 13 report from Thomson Reuters and the National Venture Capital Association, venture capitalists nationwide invested $476 million less in the third quarter than in the same period last year. The previous week, a report titled “R.I.P. Good Times” leaked from Bay area venture firm Sequoia Capital.
The report predicted rough waters ahead for start-ups and the venture capitalists who fund them. It advised the firm’s portfolio CEOs to raise money fast, build a strong cash reserve and snag lucrative exits where they can.
Reports surfaced of similar warnings from Silicon Valley heavyweights such as Angel investor Ron Conway and Benchmark Capital. The message was the same: Raising money is going to be tougher than ever.
But Cohn argues that the doom and gloom predictions stem from Silicon Valley’s habit of funding technology in search of a problem, rather than technology to solve a problem. He points to companies such as Twitter, an online service that’s racked up $15 million in funding and has millions of users but no revenue.
“The Bay area mentality of giving it away for free and trying the YouTube approach doesn’t work,” Cohn said. “In Southern California, we don’t have unlimited sources of capital, so companies have to make money when customers use their product. Managers down here know they don’t need $15 million to $30 million to grow a company.”
Santa Barbara-based BioIQ is a prime example. The start-up provides at-home test kits for conditions such as diabetes and Web-based software to track results. It partners with large companies and health management firms to gather anonymous health data on employee populations to guide policy decisions. Earlier this year it received a B-series round of $2.5 million from Carpinteria-based Great Pacific Capital.
BioIQ has a core customer base and is going directly against the grain of Silicon Valley’s advice. It’s putting off a C-Series round of funding until next year because it’s in the midst of deals that it hopes will bolster its balance sheets. “We decided we wanted a better valuation based on what we believe are going to be better numbers,” said Brent Peus, BioIQ’s chief financial officer.
In the meantime, Peus is raising a bridge round of financing through convertible notes, without any doom, gloom or trouble. “We had a good bit of success throughout August and the first part of September,” Peus said. “We kind of blasted through our minimum requirement-to-close pretty easily, and we still have a number of interested parties.”
But make no mistake – the times aren’t rosy. Venture capitalists are acting with care and stressing the basics.
“We encourage our companies to really communicate well with their existing investors and recognize that it’s going to be harder to convince other investors to jump into new things,” said DFJ Frontier Fund’s Foster. “Some of this is in recognition of the environment, and some of this is just prudent business. We fall on the side of recognizing that these are not normal times, but that these are things you should be doing anyway.”
Foster has also been emphasizing the importance of positive cash flow. “What we’re doing with our portfolio companies is focusing on what’s happening to their customers – listening to them carefully because they’re under duress,” Foster said. “You want to adjust what you’re doing to compensate for that.”