WASHINGTON-“Digital dog food is still dog food, and I think the markets are awakening to that. We had a pretty wild party last year and this year we have a hangover,” said Harry Hopper, a partner with Columbia Capital L.L.C., Alexandria, Va., describing the venture-capital market in the high-tech economy.
As is evident in the nearly 60-percent drop in the Nasdaq stock market, the high-tech industry is currently experiencing a shakeout in which companies with mediocre business plans are being purged and venture-capital firms are being forced to hold companies longer than they expected.
“Venture capitalists were distracted by markets,” said Hopper. “You could create something that looked like a public company and push them out the door. … It is a good thing that is being purged from the system. [Now] people are funding companies with longer funding horizons.”
The big problem with the “wild party” was that “real companies were not being built in many instances. … You were seeing the same thing being done over and over,” said E. Rogers Novak, founding partner of Novak Biddle Venture Partners.
Hopper and Novak were panelists at a recent Economic Strategy Institute/Alfred P. Sloan Foundation Congressional Forum on “The new venture capitalism: How does it impact the technology sector and the economy?”
This type of turnaround where venture capital firms go hog-wild to create companies and then pull back and hold companies longer when it all goes south, is part of the idea of venture capitalism, said Martin Kenney, a professor in the Department of Human and Community Development at the University of California at Davis.
“Venture capitalism is a self-correcting process,” said Kenney, who is currently studying global venture capitalism with a grant from the Sloan Foundation.
Kenney believes there has long been a debate about whether venture capitalists should fund small businesses or businesses that they expect to grow into Fortune 500 companies. Kenney believes the debate since the 1930s has proven venture capitalists’ preference for the latter.
“The debate between small businesses and venture capital has been going on since the 1930s. … What venture capital has funded is new industries rather than new firms. … That has been the key to venture capital rather than funding small businesses,” said Kenney.
One problem with venture capitalism is that it seems to know what will work and what won’t work and will only fund or not fund those companies, said both Novak and Hopper.
“If you were not Webbed and wired, you were probably not funded in the last couple of years,” said Novak describing the past venture-capital attitude.
“The marketplace is sort of at a stage right now of `Don’t confuse me with the facts,’ [and] the idiot factor [of] `If this company fails, I will look like an idiot,” said Hopper, describing the current negative attitude toward high-tech companies that may have good business models that at other times would be instantly funded but right now are scrambling to get funding.
A statistic that proves the funding biases of venture-capital firms is that only half of the companies that went public in 1999-at the height of the wild party-had no venture-capital backing, according to Patrick Von Bargen, executive director of the National Commission on Entrepreneurship.