Venture capitalists -- many of whom sat out the bear market with their wads of cash largely untouched -- are beginning to increase their investment activity, new data indicates.
But while any loosening of the purse strings comes as a welcome sign for startups, tech entrepreneurs say the climate for raising cash remains quite rough.
According to a survey (PDF) of venture capital financing released this week, VC spending for the second quarter of the year showed a sequential increase for the first time in about two years.
In all, investments for the quarter totaled $4.3 billion, up from $4 billion in the first three months of the year, according to the quarterly MoneyTree report, prepared by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association.
Although spending dropped from the same period last year, when funding approached $6 billion, researchers interpreted the sequential rise as a modestly positive sign. They attributed quarter-to-quarter gain to increased investment in software, biotechnology, medical devices and telecommunications.
For entrepreneurs, the rise in VC spending was too limited to spur a dramatic change in the overall funding climate. Anecdotal evidence suggests that companies are still assigned much lower valuations by venture capitalists than what was typical during the boom years. And investors are increasingly persnickety about the kinds of business models they will support.
"There are definitely signs of confidence," said Laura Roden, president of the Silicon Valley Association of Startup Entrepreneurs, who says the current climate is clearly "better than a year ago, when more often you couldn't get a deal done at any price."
One bit of evidence Roden cited to support this trend is the growing demand from VCs for slots at breakfast meetings the group arranges for entrepreneurs to meet venture capitalists. VCs attending meetings of valley entrepreneurs also have spoken optimistically about the market for private investing, Roden said.
But while interest levels may be up, funding commitments to individual firms are not.
"Even though capital is being released, we're not seeing valuations being increased," Roden said. When mature startups seek later rounds of funding from VCs, they're often getting less money than they did in earlier rounds. This is the reverse of what happened during the boom.
In addition, Roden said, many private investors are more comfortable making smaller investments in early stage companies. These so-called angel or seed investment rounds typically cost between a few hundred thousand dollars and a million dollars, as compared to several million dollars for a mature startup.
The MoneyTree report also documented a rise in early stage investing. For the second quarter, entrepreneurs contributed an estimated $775 million to 153 startups seeking first-time financing, up 12 percent in dollar terms from the prior quarter.
Typically, early stage firms attract investors with higher risk tolerance. Although new startups are more likely to fail, those that succeed reap greater gains for investors.
John Taylor, vice president of research for the National Venture Capital Association, sees the rise in early stage investing as a positive sign, given that such activity generally occurs at the start of a market recovery. Many of the firms that grew to prominence in the 1990s, including Starbucks, Palm and Intuit, he noted, received venture financing early in the decade, when the economy was still weak.
Nonetheless, Jacques Benkoski of Monterey Design Systems, a Silicon Valley firm that recently secured a $10 million round of venture funding, cautions against pitching a business plan predicated on overly optimistic forecasts.
"I think none of the investors I have talked to would buy into a business plan that assumes a recovery," he said. Instead, Benkoski said, he persuaded investors to back Monterey by explaining how its business of developing prototype designs for silicon chips would draw demand even in an economic downturn.
Earle Humphreys, vice president of marketing for Solutionary, a security outsourcing firm that recently secured $13 million from private investors, says another good approach, if financially feasible, is to build up the business before seeking outside funding.
In the case of Solutionary, Humphreys said, executives waited until they had a product and at least 100 customers before looking for private investments.
When wooing investors, venture researchers say, it also helps to show that those most familiar with the business are willing to contribute.
"For companies today that are looking for their first round of financing, the very best thing you could bring to financers would be a commitment by your customers to help fund you," said Kirk Walden, director of venture capital research for PricewaterhouseCoopers. "That's a ringing endorsement of the potential of your product."
When that's not possible, he added, the least founders can do is demonstrate to VCs that they themselves are fully committed, even in a challenging economic environment.
"The running joke is, yes, you do have to quit your day job," he said.
