A panel of venture capitalists with more than 75 years of combined experience took turns Tuesday mocking the ridiculous amount of financing doled out in recent years to shaky technology companies—much of it from their own firms— but stopped short of guaranteeing it wouldn't happen again.
Despite their self-flagellation, the VC executives speaking at JP Morgan H&Q's technology conference admitted that it's entirely possible, if not likely, that they and other private financing sources will again get caught up in the money-grabbing frenzy the next time around.
It just might take a generation. Or two.
In the meantime, fledgling start-ups and even established companies that actually make money will find it very difficult to secure substantial financing for at least the next year or two. That assessment is backed up by the latest venture capital survey, which showed first-quarter venture capital investment fell 40 percent from the fourth quarter.
According to the PricewaterhouseCoopers MoneyTree Survey, in partnership with VentureOne, companies raised $10.1 billion in VC funding, down from $16.8 billion in the fourth quarter. The decline is the largest ever.
"A huge amount of money was invested in companies that had business models that don't work," said Roger McNamee, co-founder and general partner at Integral Capital Partners. "There's a lot of dead wood that needs to be cleared out."
Phil Young, general partner at U.S. Venture Partners, said it's looking "very, very ugly for this year."
After shelling out an astounding $90 billion in financing last year, leading venture capital firms this year are cooling their heels not only for start-up capital but follow-up financing that's often necessary to boost healthy companies to the next level.
In the first quarter of 2001, only technology companies managed to launch an initial public offering, raising a paltry $468 million, according to venture research company VentureOne. It marked the first quarter in more than two years that less than $1 billion was raised during a quarter.
For comparison, during the first quarter of 2000 more than 70 venture-backed companies went public, raising more than $7.5 billion.
"In 1983, the venture capital industry exploded to around $4 billion," said Jeffrey Chambers, managing director at TA Associates. "It stayed at that level for about 10 years. Now it's over $90 billion. That's a staggering increase."
Larry Barken, managing director of Nest Ventures, has seen the dramatic change in venture capital mentality in the past year. His firm solicits financing for private companies from venture capitalists and large corporations.
"It's changed a lot in the past year," he said. "It used to be, you could get five, 10 or maybe even more times a company's forward sales in a private investment. Now, companies and VCs want to see profits. And then there they're likely to only offer one or two times the company's forward revenue."
All the panelists agreed that immature companies were over-financed and rushed to the public markets in the past two years, virtually guaranteeing a high rate of failure regardless of the company's technology or ill-defined business model.
"These companies had to acquire functionality and try to integrate it overnight," McNamee said. "It was a train wreck."
Chambers said venture capital firms, to varying degrees, were all guilty of rushing these companies to the market and now have to live with the consequences.
"All of us took our eye off the ball regarding business models," he said. "We're all going to be a lot more cautious in the next few years."
Shahan Soghikian, general partner at JP Morgan Partners, said the sheer volume of deals combined with the white-hot stock market made it all but impossible for VCs to extensively research these companies' business models before approving multimillion-dollar investments.
"We all try to avoid it," he said. "But the euphoria sucked everyone in."
In order to avoid making the same mistakes again, venture capitalists now must re-evaluate what constitutes a growth company in these languid economic times.
"What are real growth rates any more?," McNamee said. "Twenty to 25 percent? And what is that worth? It's not worth five or seven times revenue."