Venture capital. Funding for fresh ideas is on the rise. In US, a sag yields to long-term appeal
You'd expect Sherm Muller to flash around town in a Mercedes-Benz or, at the very least, a fiery little BMW. After all, he's a venture capitalist, a member of an elite group of financiers who have flourished in the 1980s: aggressive risk-takers willing to put dollars behind the ideas of entrepreneurs.
But somehow, Mr. Muller seems to have missed that boat. Although he is a general partner in Colorado's largest venture partnership, the $34.5 million Columbine Venture Fund Ltd., his car keys work the ignition of a Volkswagen.
The VW is a good fit, though, as much for Muller as for his industry. In 1983, venture capitalists knew no wrong. The high-technology companies they financed were the sweethearts of Wall Street, selling both privately and publicly at prices that made a financial genius out of anyone who owned a piece.
Computer companies, software companies, biotechnology companies, semiconductor companies -- venture capitalists were mad for them, so much so that some entrepreneurs could bargain-shop among different venture funds. Yesterday's darlings, however, became today's disappointments. Coming down to earth
The marketplace caught up to high-tech and wrenched it back down to earth. For much of the venture industry, that means ``no more life in the laser lane,'' as Muller puts it.
For new venture funds, especially those that have remained true to reliable business practices, the pickings are uncommonly good with the recent improvement in returns of high-tech ventures.
But by one estimate, some 40 percent of the companies already held in the portfolios of established venture-capital funds are in trouble. Venture Capital Journal estimates that while more than 100 private venture funds raised $3.2 billion in 1984, compared with $3.4 billion in 1983, much of that money now goes to keeping existing companies afloat rather than starting up new ones.
``There is still plenty of capital in the industry, but all or most of the major partnerships have problems with their portfolio companies,'' says Foye F. Black Jr., manager of the Boettcher Venture Capital Group, a publicly registered, $10.7 million limited-partnership fund of Boettcher & Co., a Denver-based investment banking firm.
For Muller and others, venture capital has simply returned to the way it should be. ``A lot of people in this industry were trying to build companies and bring them to market in two or three years,'' he says. ``Now we're getting back to the long-term perspective. That's what venture capital is, long-term money.''
``It's a cyclical business,'' says Karen Casey, associate editor of Venture Capital Journal. ``It's come down to earth from 1983, but the industry is still very healthy. In 1983 there was phenomenal activity in the new-issues market, and lots of companies rushed to take advantage. They got into trouble . . . the industry is used to these cycles.''
Those cycles generally go about five years. So, although the established funds nursemaid their portfolios, newer funds, unburdened by such troubles, have the pick of the crop. High-tech's appeal
A segment or two of high-tech may have stumbled, but technology is still the venture capitalists' honey pot. Biotechnology, medical technology, office and factory automation, computer-aided design, integrated circuitry, etc., still appear to be key elements in the growth of American industry.
Paragon Partners, a new venture fund near San Francisco, had no trouble assembling $40 million last year from institutional investors. Paragon plans to concentrate solely on leading-edge companies in high-tech.
The partnership brings a unique angle, says general partner Robert Kibble; he is from Paragon's fourth general partner, a high-tech consulting firm called Talyn Associates that will supply engineering evaluations on investments.
``The fundamental trend in technology is just not going to go away,'' Mr. Kibble says. ``There are still risks. . . . Sometimes venture groups leap into a sector and finance four or five products going after the same market niche.'' In the last surge, for example, there were 22 IBM-compatible computer companies in the marketplace, many of them venture financed.
``But the basic fundamentals are such that there has been such a wealth of scientific knowledge built up since World War II that we are going to ride that for many years,'' Kibble says. ``It's going to be translated into products.''
Columbine also invests largely in technology-based start-up ventures. Though the shakeout in personal computers keeps the firm away from that segment, office automation, factory automation, medical technology, biotechnology, and electronics in general ``look very good,'' says Columbine manager Mark Kimmel.
Both Mr. Kimmel and Mr. Black marvel at the abundance of deals backed by competent management and careful business plans.
``We've seen 300 deals in five months,'' says Black, whose fund makes investments averaging $500,000 each. ``Of those, I would say about 100 are worth financing.'' Tenfold return in five years
Especially to their liking are the prices. Venture capitalists buy preferred stock in a company, priced as a multiple of earnings (real or potential). The amount of stock issued to the venture and to other investors also determines the venture capitalists' ownership percentage, which is crucial when the investors sell out.
``The rule of thumb is that we look for 10 times our money after five years,'' says Muller. ``That might mean building a $50 million company in three to four years, which is very difficult but achievable. Two years ago we were seeing [companies with] valuations that required building a $200 million company in that time.''
Columbine Fund, for example, recently bought 50 percent of a medical company at $10 a share. In 1980, the same company was valued and financed by another venture capitalist at $27 a share.
``Companies that used to be priced at 30 and 40 times earnings now come in at six and seven times,'' says Black. Valuations in general, he says, have settled down to one-third of 1983 levels. He reaches to a corner of his desk for a copy of PC World magazine to show why.
``What do think a 10-megabyte hard disk for an IBM [personal computer] costs?'' he asks. When a reporter stakes his reputation on $1,200, Black replies, ``Well, when IBM first introduced it, a hard disk sold for $1,995. I don't follow that market, but I'd bet you can get one now for $800.'' He flips through the magazine ads and finds the item. It sells for $619.
The proliferation of computer-related companies, backed by eager venture investors, pushed both stock and product prices deeply downward.
Another factor favoring newer funds: Five years ago, a venture-capital partnership backed by more than $100 million was the impossible dream.
Today there are dozens, and they can't be bothered with small companies, no matter how promising.
``It's much harder to get a good return on $100 million than $10 million,'' one fund manager says, ``so these guys have to find companies that are going to make it big in order to achieve the kind of return their partners [the investors in the venture partnership] expect. . . . I called up one of these managers to see if he was interested in a company we were looking at. When I said we thought it could be a $50 million company, he said he couldn't afford to even look at something under $100 million.''