Wary Venture Capitalists Looking for an Incentive
With Wall Street in a depressing plunge that shaved another 6% from the average stock price this week, it’s not exactly the best time for small companies to go begging for capital. But 32 such hopefuls still showed up in Newport Beach on Wednesday and Thursday.
The companies, mostly very young, private, Southland firms, made presentations to venture capitalists and other big investors at brokerage Cruttenden & Co.’s fifth annual conference on emerging growth companies.
In many ways, the conference was a microcosm of the sad state of business and financial markets worldwide today. There are plenty of entrepreneurs with hot ideas. But the sliding economy, plummeting stock market and dangerous Mideast situation have left investors more skittish than ever about pumping money into new ventures.
Worse, many of the conference attendees agreed that the global capital crunch will become more severe before things bottom.
Yet C. Gerald Diamond, general partner with the investment firm EG&G; Venture Management in Mountain View, said the problem isn’t the supply of capital. His firm, for example, runs a $50-million venture fund.
“There’s a tremendous amount of venture money available,” he said. Rather, the problem is the rising reluctance to commit capital. “You just have very cautious venture capitalists now,” he said. “Almost all institutions are frightened.”
Many investors say the venture-financing outlook is more tenuous because the government refuses to create an incentive for long-term investing. Most attendees at the Cruttenden conference decried the battle in Congress over a new capital gains tax cut. The investors say the need for such a cut is glaring. Not surprisingly, they are hoping that Congress will resurrect an idea from the original budget compromise, that of giving tax breaks to investors who fund small businesses.
“ ‘Crisis’ is probably not too strong a word” to describe the funding environment for young businesses without some new mechanism to encourage risk taking, said Harvey Dixon, a financier with Palmer Partners in Menlo Park.
For an entrepreneur like David L. Auchterlonie, that attitude is of deep concern. He is president of Airtrax, a Los Angeles-based start-up company that has developed an electronic system that verifies whether commercials run on network and independent TV stations. Verification is a key issue for advertisers, who now must manually confirm that their ads ran as scheduled.
Airtrax has spent three years creating its system of encoding and monitoring commercials. Now, it is seeking up to $8 million in capital to launch the system.
Auchterlonie is worried that the cost of capital will only rise in the years ahead, if the nation’s savings rate doesn’t improve and if foreign investors desert U.S. markets as the dollar falls. So his firm hopes to get what it needs now, before things deteriorate further.
For a small firm hoping to survive, he says, “Only two things count now: sales and cash.”
At Carlsbad-based Microbics Corp., about $4 million in cash would come in handy to fund its rollout of new products. The firm, which lost $600,000 in fiscal 1990 on sales of $3.53 million, produces systems that measure levels of toxicity in liquids and solids.
The federal government and numerous water waste-treatment plants already use Microbics’ systems, which quickly test for poisons by exposing a light-emitting bacteria to a sample of water or other substance. The amount of light thrown off by the bacteria indicates the poison level.
As bullish as the company is about its own prospects, however, one of its officers admits that the economy as a whole looks very scary. James W. Dowe III, Microbics’ executive vice president, said he has studied previous periods in U.S. history when government, business and personal debt has piled up wildly. In each case, he said, the debt spiral was followed by a major deflation cycle.
Then why did scores of venture capitalists and other firms show up at the Cruttenden conference? Because as dismal as the outlook may appear, business isn’t just going to grind to a halt in this country. People with good ideas will find financing harder to get, but many will still get it, because 10-to-1 payoff potential still lights up the eyes of every seed-capital investor.
That kind of return might be found in a young firm like Image Data of Pasadena, which has developed software for enhanced three-dimensional imaging on computer workstations. Or a big payoff might await someone willing to finance Ruth Feinberg’s Jewish Mother’s Soup Inc., an Anaheim firm that this year expects to sell $160,000 in low-sodium chicken soups that Feinberg markets as “My Liquid Hug to You.”
How many of these companies will survive and prosper is anyone’s guess. But Peter Pomeroy, who represents financiers OSCCO Ventures, an $18.5-million fund based in Menlo Park, says that no matter what happens to the broad economy, entrepreneurs will continue to create new products and services that satisfy unfilled needs.
If the need is great enough, he notes, smart capitalists will realize the potential in funding the venture and marketing the product.
The decision to commit cash is always a function of fear versus greed. Fear has the upper hand now, but greed remains a powerful force long term.
Briefly: A comment from more than a few venture capitalists at the Cruttenden show: Stocks may go much lower, but many already are looking pretty cheap. In fact, a financier from a big New York venture firm said he believes that “the public market (stocks) is more attractive than the private market (venture investments)” now. Given that the average venture capitalist expects venture deals to return 30% or more annually, that suggests the long-term potential in stocks is even better than that. . . .
New York’s Chemical Bank on Thursday became the latest major bank to slash its dividend. The market is speaking loud and clear about the other banks and S&Ls; that are likely dividend-cutters: Just look for dividend yields that are already in the stratosphere. That tells you that the market sees no hope the payouts will last. CalFed sports a whopping yield of 31.1%--a $1.40 annual dividend on a stock that now sells for $4.50 a share. Other candidates: First Interstate, yielding 16.6%, and Glenfed, at 13.5%.
BIG IDEAS, LITTLE CAPITAL
Here are some of the small firms that attended an emerging-growth company conference in Newport Beach this week, searching for capital from investors.
Company,headquarters, Est.’90 revenue Capital sought business (millions) Image Data, Pasadena, $4,257,000 $4.0 computer imaging software Jewish Mother’s Soup, Anaheim, $160,000 $1.5 kosher, low-sodium soups Phase Medical, Santa Ana, $16,000 $2.5 I.V. therapy products Microbics, Carlsbad, $3,530,000 $4.0 toxicity measurement systems
