Why It's Pouring VC Cash
(Business 2.0) – The forecast for entrepreneurs during the next few months? It'll be raining—cash. Consider Flickr, a popular photo-sharing-meets-social-networking site based in Vancouver, British Columbia. When it went live a year ago, it attracted plenty of notice and even pulled in a few angel investors, such as Excite co-founder Joe Kraus. But that's nothing compared with the torrent of offers it's entertaining now. Google and Yahoo want to buy it outright, while venture capital firms are flooding it with all kinds of creative proposals. "We get four or five calls a week from VCs," says Stewart Butterfield, who co-founded Flickr with his wife, Caterina Fake. "We even had a health-care fund call recently. I guess they wanted in on the excitement."
That excitement reaches far beyond Flickr. In fact, the first half of 2005 could usher in the biggest flurry of financing the technology world has seen in years. Remember all that money raised in 2000? Most of those fat funds will be closed to new investments after 2005, so VCs have to use that money now—or lose it. According to Keith Benjamin and Pascal Levensohn, managing directors at Levensohn Venture Partners, a huge chunk of the $13.5 billion in VC "overhang" will pour into startups in the next four to six months. If VCs can't spend the rest of it this year, they must return the unused portion to investors. Even worse, they'll have to relinquish the 2 percent management fees they've collected over the years. That means passing up tens of millions of dollars—unless, as one VC puts it, "I can shovel money out the door."
The shovels are already in hand. If you're in a hot sector like wireless networking, e-commerce, voice over Internet, or mobile content, consider this the ideal window for grabbing some venture capital. Though some VCs worry that the surplus will lead to hyperinflated spending, don't expect another bubble. On the contrary, Benjamin and Levensohn say the spending spree could finally return some much-needed equilibrium to the VC world. Sure, there will be a short-term spike in the number of deals, but looking forward, Levensohn notes that VCs are now raising more modest funds and thus shouldn't run into any overhang problems down the road. "People will start finally paying the right price for companies," Benjamin says.
And just who's grabbing the cash in the meantime? Already, wireless networking companies like Airespace and Trapeze Networks, as well as Wi-Fi gadget maker Vocera Communications, have gotten added cash infusions. Voice-over-Internet provider Vonage, too, has pulled in huge amounts of venture funding and may launch another round soon. Mobile-gaming startups like Sorrent and Mforma also have raked in tens of millions. In fact, Mforma has spent only half of the $40 million it raised last summer, and VCs are fighting to grab a bigger chunk of the company by ponying up more capital, says Mforma CEO Dan Kranzler.
One immediate effect of the VC open season: All those cash-laden private companies, like Mforma and Flickr, will become tasty acquisition targets in the coming months. VCs will be eager to offload their more attractive ventures so they can at last deliver a return to their investors, and big companies are in an acquisitive mood. Cisco is a likely suitor for Airespace and Vocera, while Monster Worldwide could buy professional-networking site LinkedIn. With an eye on owning the middleware market, IBM might snatch up open-source software maker JBoss. Furthermore, Yahoo may want to get its hands on affiliate marketing startups Fastclick and LinkShare. In tech, when it rains, it pours. — MICHAEL V. COPELAND
Look Out Below!
The difference between the money VCs have raised and the amount they've invested—called "overhang"—will prompt them to pour billions into startups in the coming months.
Sources: Levensohn Venture Partners; National Venture Capital Association; PricewaterhouseCoopers; Venture Economics