Tech Startups Face New Reality

The days when a young software hotshot could raise millions by talking to a gray haired millionaire she met in a coffee shop are over. Today, technology startups seeking venture capital investments encounter a financing landscape that presents a different, more discouraging picture.

For those early-stage entrepreneurs, however, with unique technology and a viable business model, venture capital funding is increasingly becoming available. The trick for the entrepreneur is to position the startup so that it is viewed favorably in today’s more risk averse, back-to-basics investing climate.

In today’s market, venture capitalists are often focused on later-stage companies, spin-offs, and public companies, which are often valued as low as any startup. VC's that invest in startups are demanding greater preferences for their investments. They are also negotiating lower company valuations, investing smaller amounts and linking additional funding to the achievement of financial or product development milestones.

Venture capital is returning to its roots. What was once old is now new again. Funding is being provided to startups with terrific growth prospects that utilize proprietary technology to solve a “point of pain” in an industry or organization. The paradigm is real companies with real business plans solving real problems.

In today’s climate, “bootstrapping” is often a necessity. Bootstrapping is a means of financing a small firm through the creative acquisition and use of resources without raising equity from traditional sources. Bootstrapping is characterized by reliance on personal savings; funds from friends, family and “angels”; internally generated retained earnings; credit cards; second mortgages, and customer advances, to name but a few sources.

Of course, some ideas require capital beyond the means of the founders of the business. Yet, for most startups, gone are the days where the “big idea” plan is presented to the venture fund, a large gob of money is obtained and then the work begins. Today, venture financing is more likely to go to companies that have spent their own time and money to develop a proprietary technology and that actually have paying customers, if not profits.

As to exit strategies, until a stronger IPO market emerges, venture capitalists are looking at mergers and acquisitions as their preferred liquidity events. To receive funding, technology entrepreneurs are well advised to plan to be acquired by a major player in the industry.

It is not enough, however, to simply talk about being acquired. The entrepreneur should envision the scenario in detail: How will it happen? Who are the likely acquirers? What kind of acquirer will it be? How will valuations be determined? What is the likely timetable? The business model an acquirer is most likely to find attractive in today’s market is one that has seen not only rapid growth but also profitability within three to five years.

Another key to success is adaptability. Business plans with built-in flexibility have the best chance for success. For example, if you are unable to raise the $1 million you are seeking from traditional venture capital sources, but can raise $300,000 by going to individual investors, consider adjusting your plan to make the smaller amount work.

And forget about pie-in-the-sky valuations. Living with reasonable initial valuations is essential for a start-up to receive venture funding. This means that entrepreneurs should be prepared to give up more of their ownership interests in order to obtain financing.

Finally, it pays to be in a “space” that is currently in favor. Hot areas for investment include computer and network security; wireless networking technology; internet infrastructure, certain biotechnology and healthcare sectors and business application software.

It is not enough, however, to be operating in a hot space. What is needed is a unique technology, a viable business model, a head start in the marketplace and a cost-effective solution that addresses a true “point of pain.” The paradigm is real companies with great prospects and real business plans solving real problems.

This is an updated version of an article originally published in the PIttsburgh Post Gazette