Venture Capital After The Fall

How the dealmakers see it

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Considering the late-autumn violence wrought on the stocks of public companies, from AAR Corp. on the NYSE to Zymos Corp. on NASDAQ, the portrait of precrash innocence that appears on the back page of this magazine is not likely to return for some time. The charts through September do not reveal even a suspicion of the peril that was soon to befall them.

On careful examination, though, perhaps there are some hints: the stubborn failure of the INC. 100 Index -- the fastest revenue growers in the land -- to participate in the bull market; the Dow Jones Industrials being bid up blissfully past a collective price-to-earnings ratio of 20, as if those 30 ancients were the sprinters; the month-after-month magic gains of untested initial public offerings in the aftermarket. Sure, excesses eventually get their comeuppances, as we have learned from Dutch tulips and Hunt silver and a dozen other pinpricked balloons, but what, pray tell, were investors indulging in this time to warrant the vaporizing of $500 billion in a single day? Weren't earnings expanding, wasn't there ample cash around, weren't assets solid and balance sheets sound, wasn't entrepreneurship earnest? And hadn't Wall Street's truly greedy denizens already been thrown in jail? Be justice as it may, you can't argue with the market. What happened happened, and fiscal life must go on.

Perhaps reassurance can be found among those who beget that life: venture capitalists. If it turns out that these risktakers have skulked away from the mass destruction of their own noble instruments -- shares of corporations -- one would be concerned for the underpinnings of commerce. Not only would energetic new businesses not be founded, but maturing companies wouldn't get the unencumbered money they will need to push forward from here. Nobody would be able to sell stock to a rightfully dubious public.

Let us not despair. Maybe it was only professional bravado, but one immediately encouraging sign during October's panic was that venture capitalists actually answered their phones, which was more than some over-the-counter dealers and mutual-fund managers did. And from the testimony gathered from a trio of practitioners, it would seem venture capital is relatively undaunted by the rape of stocks.

"I don't follow the market, and I don't really care what happens," proclaims Stanley Pratt, a 25-year VC veteran who is general partner of Abbott Capital Management, a venture-fund investment management firm in Wellesley, Mass. "I would say it's a little distressing," hedges Don Valentine, general partner of San Francisco's start-up-oriented Sequoia Capital, "but it will have no bearing on whether we invest or not." Adds William Hambrecht, president of Hambrecht & Quist, a San Francisco-based venture capital firm, "When emotions clear, the market will catch up with performance. If you build a growth company, the market will recognize it."

And if there's a recession? "We'll manage to handle it," Pratt promises. Venture capitalists have learned a great deal since 1982-83's indiscriminate surge in start-ups, says Pratt -- a period he calls their "silly season." One lesson was that you can't get away too long with foisting earnings- and history-less companies on the public merely to secure 40% annualized returns for a few venture partners. Not that the players ultimately deemed their royal return on investments unfair to the populace; it's that the shaky enterprises they spawned didn't endure. For example, of the 44 disk-drive companies that were funded around silly season, only about half a dozen survive today. And if October's careening equities have dictated a deep freeze in which capital spending will be severely curtailed, several of those will probably disappear.

On the other hand, Hambrecht proposes, perhaps technology is not as dependent on capital spending as people think. The new generation of technology will "force a move in product that's more important than the economic climate," he reasons. Companies will have to spend for advances in technology, because they won't dare risk forfeiting competitive advantage.

Thus unfazed, high-tech specialist Hambrecht & Quist, which has about $800 million locked up in 10- and 12-year venture pools, will continue to invest, says Hambrecht. "Prices are a lot more attractive now," he feels, "and the sources of our money aren't running away." Because of the drop, H&Q will look harder at mezza-nine financing -- a later round of equity that, because the enterprise in question is older and hence a safer bet, is usually more expensive than start-up funding. But the crash is narrowing the gap. "Now there's a chance to buy in 50% at what amounts to start-up prices," Hambrecht observes.

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