Market Study Preview: Sand Dollar Report 2003

by Wendy Hall, Larta Staff Writer
Ketaki Sood, Larta Research Economist

"2002 was one the worst years for the VC industry," says Brad Jones of Redpoint Ventures, one of the leading venture capitalists interviewed for The Sand Dollar Report 2003, Larta's annual study on venture investing in Southern California.

To be launched just prior to Larta's April 3 Venture Forum conference, the upcoming report provides the most current data on the VC industry in Southern California. Nationwide, the amount of VC investments fell by *33.26 percent between 2001-2002, while the number of investments fell *37.35 percent. Early stage funding predictably took the heaviest hit, declining over 56 percent as both VCs and angel investors refocused their interest towards companies with revenue streams, a customer base, and proven value proposition. Yet, one of the negative misconceptions that has come out this lack of VC funding is that there is no financing available, which Jones says is often not the case. Because the quality of the companies is more carefully scrutinized and the bar has been raised for what makes a fundable startup, many companies are not receiving A-round financing because they're just not passing the higher threshold, not necessarily because of a lack of money among investors.

Although this indicates a sobering spending trend for startup companies, it has also given way to a new breed of angel investors, ones that tend to have a more dedicated interest in developing new technologies and companies than the angel investors of the late 1990s.

"Less experienced angel investors have fled the entire venture capital asset class, but they are being replaced by committed entrepreneurs that continue to be passionate about early stage technology companies," says Joel Balbien of Smart Technology Ventures. "I think the message for entrepreneurs and start ups is they really need to work to conserve capital. They are also forced to be as productive as they can with the investment capital that is available to them, breaking even or generating positive net cash flow with less money than was available to companies in the past."

Regional Issues

Although Southern California VC data mirrored the drop in venture capital spending that occurred nationally, Southern California's technology industry continued to wrestle with its unique set of strengths and weaknesses. There are still not as many "venture-type" companies in the region as there are in Silicon Valley, which results in not as many innovations, collaborations, entrepreneurs and critical mass (although the regions are surprising similar in total number of technology companies: 11,677 in Southern California vs. 13,280 in the Bay Area). Also, companies in Southern California suffer from being dispersed across many counties, leading to limited interaction between companies, and limitations on the emergence of new ideas. However, the lower cost of living (compared to Silicon Valley), and a growing talent pool still continue to be Southern California's strong points. Yet, the increase in government defense and security spending may position Southern California quite favorably in the next few years, because of its strong roots in the defense industry. Despite these factors, the amount of venture capital deal flow in technology is likely to continue to be just as limited if not more so in the coming year.

"The venture industry is still alive, but has protracted significantly as some of the numbers have indicated," says Bridget Karlin of Red Siren, a venture consulting firm. "Yet, this has become a kind of corrective action for the re-synchronizing of what venture capital was originally purposed for--to propel growth of strong, promising companies. Thus, we are gladly back to that original premise."

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*Source: PricewaterhouseCoopers; Larta