Capital Without the Venture

In today's static venture-capital markets, only the safest early-stage firms get the money.

Eye for Management

Of course, that $4 billion per quarter is going somewhere. Currently, life sciences accounts for nearly a third of total investment, up from an historical level of 10 percent. (Under that heading, biotechnology grew steadily last year, while the medical-devices area held its own.) Information technology—still the largest target for venture capital—has shrunk to 60 percent of total investment, from 70 percent in the Internet’s heyday. Across all categories, though, VC firms have been looking for solid management experience at the start-ups, and some semblance of finance discipline.

Management skill is one reason that IT consultancy Form + Function Consulting Inc. broke through to its first VC infusion late in 2001. By developing a business plan tied to immediate needs, IT-marketing veteran Bob Bernard was able to convince VC firm Wheatley Partners that year to sign on for 27 percent of Form + Function, while a second VC firm, Topspin Partners, took about 20 percent. Total financing: about $8.5 million.

“We were very fortunate because of the model we were bringing to the market, and the experience of our management team,” says Bernard. By then, things were very different from the “more-opportunistic VC market” of the 1990s, when start-ups got money when they lacked management “but seemed to have a good concept.”

With a second $6 million round in 2003, Form + Function was able to acquire divine/Whittman-Hart Inc., a consulting firm whose core Bernard had founded in 1984 and run successfully for years—before an ill-timed merger led it into serious financial trouble in 2001. (The new company is called Whittmanhart.)

According to Paul Wimer, managing director of Roslyn Heights, New York based Topspin, Form + Function stood out because of Bernard’s previous ability to start and grow a substantial consulting firm. Bernard’s company offered measured ROI, and a customer guarantee, as part of its formula. “This was a space we knew well, and a person we trusted,” says Wimer, who himself worked previously at Andersen Consulting.

Because Bernard’s experience also included making the merger that had hurt his former firm, the VC firms kept a close eye on him and his CFO, Scott Knoll, until they were certain the two were on the right path. “Our initial discussion point was, ‘Do we need to have a stronger CFO on board?’” says Wimer. Monitoring was especially intense when Form + Function acquired divine/Whittman-Hart, because that deal required additional capital. To be extra careful, the VC investors have kept in contact with a former CFO of the old firm—someone who knew Bernard well. But annual revenues have grown from $1.5 million in 2001 to $25 million last year, according to Bernard. And Wimer says the company is close to breaking even, and is on course for a possible IPO or other sale in about two years.

A Mysterious Cycle

Whittmanhart is shaping up to be one of a number of successes of $213 million Topspin, which Wimer describes as a “generalist venture fund,” with 23 separate investments in several fields ranging from telecommunications to biotechnology to that current flavor of the month, homeland-security equipment. “We’re about 65 percent invested,” says Wimer, who projects that by the end of the year Topspin will be moved to raise new amounts to replenish the dry powder for the first time since its initial year of 2000—a phenomenon he expects at other venture firms as well.

Among the markets where Topspin invests, Wimer doubts that biotech will get much expansion at the firm. “It’s one of those markets where you really need expertise,” he notes. In all of the life sciences, investors must look beyond the issue of whether a particular biotech or medical-device solution eventually works—a low-percentage proposition in itself—and factor in extra risk of delays from government approvals.

At Biowave, of course, those risks are all in a year’s work. Venture capitalists who specialize in biotechnology have learned to commit themselves to a blend of seed money and additional funding that is needed to support it—generally broken down into early-stage, expansion, and later-stage divisions. And through most of last year, less than a quarter of VC investment was in the form of seed or early-stage money. But from CEO Siff’s perspective, at least, there has been a noticeable mood swing in the past year toward earlier-stage investment. “I get the sense that there’s a general loosening of the purse strings,” he observes. “There are more deals, with larger amounts of capital being put to work in health care, medical devices, and biotech in general.”

Or perhaps what he’s seeing reflects expectations of a cyclical rise in overall VC investing—one of the industry’s unexplained phenomena—that may now be starting to boost all categories. For some reason, “the business cycle for venture-capital investment runs every 10 years, no matter what,” says the NVCA’s Taylor, who notes that the last strong upturn began in 1994.

Roy Harris is senior editor at CFO.

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