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This month marks the one-year anniversary of the time when America’s love affair with technology stocks began to sour. As the NASDAQ today hovers around 1,900, it seems like much more than a year has passed since the giddy 5,000-plus days of early 2000. Commentators and business journalists trot out every horror story possible about how this indicator is down, that company went belly-up and the tech darlings of yesterday are conducting massive layoffs today. Tragedy makes good copy. Tragedy befalling the cocky entrepreneurs who soared to the top while sneering at those who just didn’t get it makes better copy. The innovators have been tagged as too big for their britches. The investors labeled mercenaries blinded by promised profits. Startup companies and venture capitalists only had themselves and each other to blame if their pet projects blew up. Problem is, to paraphrase Mark Twain, the rumors of venture capitalism’s demise have been somewhat exaggerated. Not only are VCs making investments, their investment choices are growing considerably more solid. Sobered by one too many too-good-to-be-true ideas, VCs are nevertheless on the lookout for new projects, although their primary focus in many respects is to shore up their existing portfolio companies. Before the NASDAQ crash, there was a land-rush mentality among VCs. New markets erected by technological innovations spawned a whole culture of being first in line with a new idea. This “first mover” advantage was paramount; being “quick to market” was the linchpin. It didn’t matter if profitability wasn’t an immediate or even a near-term goal. What mattered was that the first in line would establish a dominant market share, which would, in turn, produce profits as the market matured. Unfortunately, the euphoria clouded a clear vision of the market as it was developing. New technological advances changed markets with great rapidity. An assumption on which a product’s success depended might vanish in a matter of days. In many cases, investors misjudged the market’s demand for a company’s technology solutions. In other cases, the amount of value added to existing products wasn’t dramatic enough to persuade customers to dump what they already had invested in for new and improved products. One type of misguided investment was in pure Internet retailers, i.e., e-tailers. These were companies like Pets.com and eToys.com that were the first to propose selling pet supplies and toys over the Internet. VCs scrambled to back the first companies offering to sell traditional products over the Internet. But, even before the Super Bowl came and went this year without a humorous ad from Pets.com, VCs knew these businesses were in trouble. An April 10, 2001, article in Red Herring notes that sales for Internet-only companies rose by 25 percent during this past holiday season, compared to a 135 percent increase at so-called bricks and clicks counterparts (the Internet sites of existing stores or catalogs). Amazon.com is one of the only pure e-tailing sites still around, in large part because of its size, but as its stock price has indicated, even it is in trouble. Another type of misguided investment might involve an engineer who patented a new technology that only added incremental improvement or value to an existing product. The engineer would seek VC financing to bring this new technology to market. The trap VCs found themselves in, however, was that in the rush to fund the project, to become the parents of the “next best thing,” they often failed to first secure a full management team. Even the next best thing needs the full complement of key business personnel to operate a business profitably. VCs got burned, too, when they got involved with Web sites that were supposed to be so helpful or so ingenious that every person with a modem would want to visit them. An example is the medical information clearinghouse site drkoop.com. Many sites were launched with no other revenue stream than banner advertisements, but with the heavy traffic the sites were supposed to generate, the money eventually was supposed to flow in. It didn’t. Even Yahoo, the king of banner advertising, which gets more than a million hits a day, is desperately seeking ways to increase revenue. What these VCs discovered was that the culture of the Internet had developed to the point that users expected to get information and even services for free. Users balked at paying a nickel to participate in an online discussion with experts from around the world or to download an entire treatise or report. BUNKER MENTALITY The stock market crash that began in April 2000 sent a lot of fledgling companies packing. VCs watched many of their investments wither and die on the vine. What seemed like a great idea at the time turned out to be a disaster. It was either home run or strike out, with very few base hits in between. Even during the grim developing scenarios, VCs were not retreating to lick their wounds. Even those who lost money on failed dot-coms or other “new economy” ventures still had money in the coffers and still had options to consider. Despite the poor stock market, record levels of VC investment continued in the second and third quarters of 2000. The most dramatic downturn in VC financing occurred in the fourth quarter of 2000 and continues today. Partners in VC firms talk about being more selective about the new companies they invest in. A VC that may have invested in a company that invented things to produce incremental value is looking at companies that have developed more dramatic inventions. For example, the VC would be more likely to invest in the company that invented the technology to take the phone from a plug in the wall to a cordless model, rather than a company that changed dial phones to push-button. The latter is a nice bonus, but the former truly changes the fundamental way in which the technology is used. Gone are the days when people with great ideas could demand a pot of gold up front, replaced by a requirement that the idea people demonstrate that they can get by on a minimal budget. That person has to have a good idea, a great market and a proven management team. That management team has to have a proven track record of profitably developing and delivering a product to the marketplace. Many VCs have moved to funding growth-stage companies with momentum in customer relationships and revenues (the traditional role of VCs prior to the Internet gold rush of the late ’90s) as opposed to early-stage pre-revenue startups. For a startup company today, a rational business model has a better chance of getting funded. So, too, will plans and ideas that are scalable, that is, not limited to a narrow segment of a market. For instance, an idea to improve the way in which a grocery store delivers its products will be an even better idea if it can be resized, adapted or scaled to fit different retail markets, such as home improvement stores. And, again, VCs are demanding to have a management team with a proven ability to deliver products into the marketplace profitably and expeditiously as a prerequisite to funding. Proprietary intellectual property is another big plus in seeking VC financing. New ideas also are being valued more conservatively — not just in the long term, either. VCs value companies in a more realistic fashion, and valuations literally change on a daily basis as more air comes out of the economy. Protecting capital and being more conservative in choosing new projects may sound like a bunker mentality. In some ways it is, but to some VCs, this is a more realistic atmosphere. This is business as business was meant to be run.

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