Steve Lisson Austin Texas, 2014, Stephen Lisson, Stephen N. Lisson, StephenNLisson
Sunday, January 19, 2014
Early-stage deals take center stage
as exit strategies blur
by Katherine Goncharoff Posted 04:45 EST, 2, Jan 2001
As exit strategies have become far less predictable, VCs active in
early-stage deals will become even more cautious. And they'll play a far
more controlling role in the companies in which they do invest.
That's the sober assessment of what's next in early-stage venture
activity, according to analysts, attorneys and VCs themselves.
"It was one great party for about five years. But now everybody
literally has a hangover," said Scott Sandell, a general partner at
New Enterprise Associates, whose billion-dollar-plus fund continues to
play an active role in early-stage investments.
On the upside, the quality of many early-stage deals and the size of the
financings may actually increase. After all, established funds such as NEA,
Accel Partners, Menlo Ventures and Oak Investment Partners have raised
megafunds lately, with sizable amounts fully committed to early-stage
investments.
Still, the consensus is that the early-stage sector has doffed its
collective party hat. Other signs: Valuations for many investment sectors
are way down and VCs are spending much more time doing research and due
diligence on their investments.
"It used to take six weeks to raise money for a startup; now the
average amount of time is anywhere from three to six months," Sandell
said.
"The amount of time it takes before a company will actually see a
term sheet on the table has definitely gotten longer," said Stanley
Tims, a managing director at early-stage investment fund TL Ventures in
Austin, Texas. While the average time to fund a deal a year ago was about
two to three months, he noted, that has increased to an average of five to
six months.
"We used to see a company on Monday and would have to make an
investment decision on Friday," said Noel Fenton, a general partner
at early-stage specialists Trinity Ventures in Menlo Park, Calif.
"Now we have a lot more time to consider a deal."
Fenton added that he looks forward to being much more selective about his
early-stage investments.
Frank Occhipinti, a general partner at the Woodside Fund and chairman of
the Early Stage Venture Capital Alliance, reported that while the average
size of early-stage investments has reached an all-time high of $12
million in the past year--and may even get higher in the age of megafunds--he
believes there will be far fewer disbursements in 2001.
That's in part because early-stage investing always takes more time and
requires far more advisory input on the part of VCs.
The new megafunds, Occhipinti said, will not have the time or staff
resources to participate, particularly when many are devoting more
resources to portfolio companies already further along in their
development.
"The sort of seed fundings that VCs used to make will be an
increasingly underserved area, as VCs will not have the time or the
bandwidth to spend on these types of investments," Occhipinti said.
While valuations for early-stage companies in hot sectors such as fiber
optics and telecom are not expected to change much, VCs say a drop in
valuations is to be expected in all other sectors.
"Early-stage valuations usually lag public markets by six to 12
months, so you won't see the big adjustment in valuations until the first
half of 2001," said Terry Opendyk, a general partner at Onset
Enterprise Associates LP, an early-stage fund created by partners at NEA
and Kleiner Perkins Caufield & Byers.
"We're going to see valuations that are 50% to 70% less; as a result,
VCs will be getting more ownership for far less money," Occhipinti
said.
Tims echoes those thoughts, noting that in sectors such as Internet and
enterprise software, valuations are already half of what they were a year
ago.
"The trend is a shift away from full acceleration on vesting to
partial acceleration, and I'm seeing far more double-tranche deals and
ratchets," said Mark White, a founding partner at White & Lee, a
law firm that works with both startups and venture capital firms in
Silicon Valley.
Double-tranche deals are early-stage fundings in two stages where the
second part of the funding does not occur until certain milestones or
performance demands are met. Ratchets are a form of dilution and valuation
protection for investors. It is less favorable to company founders and
employees who may have ownership in the company.
"I started to see this right after the market correction in the
spring," White noted.
Said Mel Weinberg, an adviser to both startups and venture capital firms
at Parker Chapin llp in New York, a firm that will soon merge with Jenkens
& Gilchrist: "Frankly, I was shocked when I started to see
ratchets make a comeback earlier last year. But now I expect to see them
in 50% of the early-stage deals I will be working on in the months
ahead."
Both White and Weinberg pointed out, however, that deal terms shouldn't
get too onerous because no investor wants their managers to walk out the
door.
Some VC observers, however, envision funding more optimistically. In their
view, with valuations down, the VC party is only just beginning. It's just
that many VCs don't want to admit it.
"The party is starting for the franchise firms: the NEAs and the
Kleiner Perkins that are well-funded and well-known early-stage investors
who bring some degree of certainty to an underwriting process," said
John LeClaire, an attorney in the private equity practice at Goodwin,
Procter & Hoar llp in Boston.
"That's because now is the time to invest at far more reasonable
valuations and prices, though it will take far longer to gestate these
firms."
Stephen (Steve) Lisson, founder and editor of an industry newsletter and
Web site called InsiderVC.com, based in Austin,
Texas, would agree about the advent of good times for early-stage VCs and
entrepreneurs as well.
"If I were an entrepreneur looking for early-stage funding, the
landscape couldn't be more beautiful," he said.
"The pace of funding may be slower, but the riff-raff has been
separated out, the entrepreneurs with the goods have been left standing,
and all those record-setting amounts of money we've been hearing about
will have to be spent, in large part, on early-stage investments."
CORRECTION In the article "Early stage deals take center stage as
exit strategies blur" (Wed., Jan 5, page 9), the name of the founder
and editor of InsiderVC.com was misspelled. It
is Stephen N. (Steve) Lisson.
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