After stock shakeout, Silicon Valley sizes up venture-capital climate
Palo Alto, Calif. — Like the legendary Midas, almost everything Silicon Valley entrepreneurs touched from 1978 to 1983 seemed to turn to gold. American venture capitalists, their coffers gradually swelling from $2.5 billion to $12.5 billion, looked for companies to invest in with growing aggressiveness. Institutional investors, lured by the prospect of large profits, were increasingly active in pre-public financing and dangling millions in the face of companies within a year or two of going public.
This culminated in early 1983 as an unprecedented number of high-technology companies tendered their initial public offerings and received record prices for their stock. Seeing company after company go public at inflated values made investors worry less about backing weak companies than about missing the next windfall. The valley was awash with money.
But then came change. During the second half of '83 and continuing into this year, the disappointing performance of several high-flying companies and a general downturn in the stock market choked the flow of venture capital. Midway through 1983, talk turned from the growth of young companies to shakeout.
Finally, after more than a year of hard times, the venture-capital situation is looking somewhat better for start-up companies - but it is still far from approximating the boom years.
Reflecting on those ''halcyon days,'' Sandy Robertson, of the Robertson, Colman & Stevens brokerage in San Francisco, comments: ''A number of things happened at once. ... It was like all the planets lining up on the same side of the solar system.''
Kip Hagopian, general partner of Brentwood Associates and a prominent figure in the Los Angeles venture-capitalist community, phrases it differently: ''In all my years in the business, I haven't seen a period of craziness like this.''
Last year's high-tech syzygy, expert investors say, was due to the confluence of four basic trends:
* Significant expansion in venture-capital funds, an ongoing reaction to the reduction in capital-gains tax.
* The microcomputer revolution, which created an unprecedented market explosion, allowing companies to hurtle from zero to several million dollars in annual sales within a year or two.
* The arrival of new biotechnology firms, which also held the promise of creating totally new markets.
* The appearance of a robust stock market as economic recovery and low inflation reignited investor confidence.
All the enthusiasm led to excesses, Mr. Robertson admits. He describes the financing process as a filter: ''From April to July of 1983, this filter was very coarse. It let all kinds of junk through. A lot of companies which should never have made it went public.''
As the amount of investment money increased, so did entrepreneurial appetites. In the 1970s, start-up operations could last on a million dollars for five years or so before turning a profit and going public. In recent years, new companies typically start with $5 million, come back for $10 million a year later, and frequently add $20 million or so with a third round of financing before going public.
''Companies began counting on unlimited quantities of capital,'' Robertson says.
Then, during the summer of '83, several well-regarded computer companies stumbled. At the same time, the microcomputer market cooled from its torrid rate of growth, and the investment community became aware that returns from biotechnology start-ups were far more remote than many had thought.
''The bottom fell out,'' Mr. Hagopian says. Tumbling prices on high-tech stocks created a reaction ''like a sewer backing up,'' he explains.
Companies on the verge of going public decided to wait for better times and returned to the pre-public financing, or ''mezzanine'' market, looking for money to tide them over. This retreat, combined with the disappointing performance of a number of initial public offerings, hurt the insurance companies, mutual funds , and corporate investors that make up the bulk of this market, explains Alan Herzig, managing director of L. F. Rothschild, Unterberg, Towbin in San Francisco. They bailed out.
''We were suddenly the only source of sustenance for a large number of young companies in constant need of money,'' venture capitalist Hagopian says.
Despite the fact that venture funds still had large amounts of money to invest, the venture capitalists found all their time taken up with the care and feeding of companies in their existing portfolios. As a result, they haven't had much time to devote to looking at new companies. And those who do have the time are demanding much more for their money than was the case a year ago.
While this turn of events has been viewed as a disaster by many Silicon Valley entrepreneurs, professional investors characterize it as basically a healthy return to normality. ''It's amazing how many entrepreneurs want to believe that last year (before the market fell) is, or should be, normal,'' Mr. Herzig says.
According to Robertson, the investment ''filter'' has simply become finer today and ''the really fine, really good companies are still getting through.''
There has been a period of overreaction, these experts acknowledge, but this seems to be bottoming out. Venture capitalists say they are beginning to return phone calls and pre-public investors are beginning to play again. But the easy-money days for high-technology entrepreneurs are not likely to return soon, many venture capitalists say. Among the concrete orchards of Silicon Valley, those days are becoming legend.