Start-ups tread cautious economic pathway
-- As the signs of a recession increase, start-ups and their venture capital backers aren't panicking. But they've learned the harsh lessons of the great dot-com crash of 2001, and they're girding to endure some economic pain.
Look at World Golf Tour (www.worldgolftour.com), a 2-year-old San Francisco start-up that offers online golfing and photography-based animations of famed golf courses around the globe.
Launched on credit cards by tech industry veterans YuChiang Cheng, Chad Nelson and JF Prata, the start-up quickly attracted "angel" investors, Battery Ventures and Panorama Capital, who've poured several million dollars into the firm.
With the economy flagging, conservative CEO Cheng is trimming costs further. He's hired 20 employees but outsources other work abroad. He's signed an affordable, short-term sublease in a San Francisco law office. He spends little on advertising, relying on viral marketing through blogs and message boards.
"As an entrepreneur," Cheng says, "your biggest worry is running out of money before you get your idea to the market. So saving a dollar buys you time."
World Golf Tour and scores of other U.S. start-ups are doing well now, although they could be vulnerable if a big recession hits. While start-ups are the research-and-innovation hubs of the business world, they don't enjoy the financial resources of large companies during long-lasting downturns.
"We're all trying to size up the storm," says Chris Pacitti, general partner at Austin Ventures in Austin. "An extended recession can have a pretty dramatic effect on a small, fragile company."
One danger sign: The market for initial public offerings — private firms going public by selling their shares in the stock market — has swooned. That means start-ups will find it harder to raise money, and big corporations will have less capital to buy young companies.
Renaissance Capital's Renaissance IPO index fell 20% through March 31. And only five venture-backed firms went public last quarter, says Mark Heesen, president of the National Venture Capital Association.
"No one is running around saying the sky is falling," Heesen says. "But there's more concern in the market today than a couple months ago."
Even "angel" investors, the wealthy individuals who give seed money to entrepreneurs, have grown more cautious. After several years of 10% annual growth, angel investments rose only 1.8% to $26 billion in 2007 from the year before, says Jeffrey Sohl, director of the University of New Hampshire's Center for Venture Research.
The deal sizes also shrank last year. "That tells us that angels are holding back a bit and trying to spread around the risk," Sohl says.
Sohl predicts that the current downturn is unlikely to match the dot-com debacle of 2001, when overfunded Internet firms with weak business plans set off a stock market crash and recession.
Why? Because today's venture investments are more safely spread across several sectors, including biotechnology, pharmaceuticals, medical devices, software, retail and media and entertainment.
"I don't see a real collapse of the market," Sohl says.
Venture capital firms aren't shutting off the investment spigots, because new technologies are long-term investments that take several years to develop, says Sunil Dhaliwal, general partner at Battery Ventures in Waltham, Mass.
"The worst thing you can do in a market like this is to stop investing," Dhaliwal says. "We still believe in these ideas."
However, Dhaliwal and other venture investors say that smart start-ups are patiently hunkering down, streamlining costs and planning the best ways to bring their products to the market.
Good start-ups get tougher during recessions, Pacitti says. Their survival instincts kick in, and they emerge stronger when the economy booms once more.
One example: Bazaarvoice, a fast-growing e-commerce firm that provides technology services and marketing analytics for businesses.
Founded by entrepreneur Brett Hurt, the start-up has received $12 million from Austin Ventures and other investors.
Pacitti calls Bazaarvoice "a model of capital efficiency" that shaves its costs by outsourcing work to the Ukraine and using free open-source software from the Internet.
By monitoring its sales data, Bazaarvoice can decide whether to keep expanding or throttle back a bit in the downturn. When the economy booms again, the company will be ready "to step on the gas," Pacitti says.
Clearly, the start-up pipeline is backing up. A record 1,168 start-ups in 2007 are late-stage firms a year or two from going public or getting acquired, the NVCA reports.
If the IPO and M&A markets continue to wither, and start-ups have no "exit strategies," the firms will need to survive longer with less cash. Venture firms will hold on longer to their start-ups, and their investment returns will shrink.
But venture capitalists remain upbeat. John Taylor, NVCA research executive, says that 1,400 start-ups are in their early stages, and venture firms last year accepted another 1,300 new business plans from entrepreneurs.
"The venture capital industry," Taylor says, "would not be putting money into new companies, new products, if they were not optimistic about what lies ahead."
Back at World Golf Tour, Cheng isn't worried. People might not buy big-ticket items in a recession, but he's betting that consumers will spend money on affordable entertainment such as online golf.
The demonstration game for World Golf Tour, which appeals to white-collar professionals, already has drawn 500,000 players, and the number of users is rising 5% a month.
General partner Roger Lee at Battery Ventures says the figure will keep growing when the full game makes its debut this spring.
Even with a potentially scary recession, Cheng is looking far beyond the next few fiscal quarters.
"We knew this would be a long-term venture," he says. "Companies with real revenue, a strong business model and a large number of consumers will do very nicely."