How start-up firms are preparing for slow times

— -- Venture firms and start-ups they fund are bracing for the slump by:

•Building financial cushions. With the IPO and mergers-and-acquisitions markets cooling, venture firms are setting aside money for start-ups to use later.

Deepak Kamra, general partner at Canaan Partners in Menlo Park, Calif., says if a start-up ideally needs $30 million, his firm might invest only $3 million up front, and save $27 million for later rounds.

"Venture firms are being much more careful about keeping reserves in place," Kamra says.

• Funding stronger start-ups. Dot.com start-ups with laughable products and no real business plans were a running joke years ago.

Now, venture firms only fund well-run firms with viable technology, strong business plans, lucrative markets and seasoned manager. And they'll be even more selective during an economic slump.

In 2000, venture firms financed 25% of proposed deals, says Sohl. Last year, they funded only 10%.

•Meeting milestones. Start-ups no longer can burn through their cash as if it was endless. Today, if young firms want more venture funding, they must meet key benchmarks such as engineering and product development goals, or sales projections.

"At the peak of the madness in 2000, it was not unusual for entrepreneurs to go off and running with a $10 million check," Dhaliwal says. "Now they'll get a half-million to $2 million to start, and if things work out in six to 12 months, they may get another larger slug."

• Courting big companies. With the unpredictable IPO and merger and acquisition markets, more venture firms and start-ups are teaming much earlier with corporate investors and potential buyers, who traditionally have entered the scene late in the start-up cycle.

"We're not afraid to get potential acquirers involved as strategic partners at a very early stage," says Dean Miller, managing partner at Novitas Capital.

For instance, Novitas Capital has teamed with Novo A/S, the venture arm of Denmark healthcare giant Novo Nordisk, and other firms to launch biotechnology start-up Logical Therapeutics in Pittsburgh.