Online Extra: Earlier is Better for Venture Capital

This year is shaping up as a very active year for early-stage companies to receive VC funding. Backers want to get in on the ground floor

In mid-August, Provenance Ventures, a venture capital firm based in Los Angeles announced that it had closed on its first Fund, $10 million specifically to back early-stage social technology, media, and communications companies. Provenance said that it expects to make 20 to 40 investments ranging from $250,000 to $500,000 per company during the course of the fund.

Not long before the Provenance announcement, the VC outfit Louisiana Fund I, part of a Louisiana state venture fund, reported that it had invested $1 million in Primorigen Biosciences, an early-stage biotech firm in Madison, Wis. And in the same month, Tendril, an early-stage provider of network-operations platform software, announced that it had secured $5.25 million in funding from the VC firms Vista Ventures and Appian Ventures.

So far, 2006 is shaping up as a very active year for early-stage companies to receive venture capital funding. According to the MoneyTree Report, a quarterly study put out by PricewaterhouseCoopers and the National Venture Capital Assn., 74 startup and seed companies raised money from venture investors during the second quarter of this year, up from 54 last year.

WARMER MARKET.

  Compared to the leaner times that followed the 2000-2001 economic implosion, entrepreneurs are now finding themselves in the position of attracting funding as more and more VCs are interested in getting in on the ground floor and investing in early-stage companies (see BusinessWeek.com, 8/3/06, "Before You Accept VC Funding…").

Why are early-stage companies suddenly attractive investment opportunities? For one, the market itself is a lot more enticing for entrepreneurs to go back out there and innovate. "When [the economy] was more challenging," says Neil Sequeira, a partner at the Boston-based venture firm General Catalyst, "executives at large companies stayed at the high-paying jobs. Now that the market is a little bit warmer, entrepreneurs are willing to get out of their comfort zones and start new projects, and VCs are willing to back great talent."

For instance, Sequeira says that last December his firm raised $400 million, following on the heels of $200 million and $300 million funds raised in three rounds since 2000. "We're seeing more money in the marketplace," he says, adding that 90% of his investments are in early-stage companies.

CYCLE WATCHING.

  Another driving factor is that the cost of doing business has decreased significantly. Technology such as open-source software had changed the metrics, and it's much cheaper for a company to launch and scale quickly compared to five years ago.

While VCs are always on the look out for the next Google (GOOG ) or eBay (EBAY ), another factor to consider is the cyclical nature of the markets. According to Mark Heesen, president of the National Venture Capital Assn., funds typically run in 10-year cycles. VCs want to get in on the bottom level, because by the sixth or seventh year a company will have grown to the point where it will be acquired or go public.

Right now is the start of a new cycle of funding (see BusinessWeek.com, 8/1/06, "15 Things You Need to Score VC Funding"). "This is a very good time if you are an entrepreneur looking for seed or early seed money," says Heesen. "[VCs] are looking a lot more closely now particularly more then they were in 2002 and 2004 when funds were coming to a close."

Stacy Perman

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE