TECH WRECK: Venture capitalists — funding the $2.8 billion D-FW bubble

TECH WRECK: Venture capitalists — funding the $2.8 billion D-FW bubble

No commodity can be at the center of a financial mania without a lot of money being pumped into it. And in the technology and telecom bubbles, much of that cash came from venture capitalists.

The numbers at the local level are staggering. In 2000, when the technology and telecom bubbles peaked, VCs invested $2.8 billion in companies in North Texas, according to Ernst & Young. By 2009, that number had shrunk to $277.5 million — a 90% drop, according to the E&Y data.

Today, it’s at a level that makes more sense in terms of companies that can benefit from venture financing, said Bryan Pearce, director of E&Y’s Americas venture capital advisory group. Pearce is based in Boston.

Venture capitalists typically provide the first institutional money that a fledgling business raises. The idea is to buy a piece of a company when it’s small and cheap, help build it up, then cash in by selling or taking it public.

During the 1990s and in 2000, the markets were receptive to initial public offerings, or IPOs, of young, money-losing businesses. With the stock market awarding high values to businesses that had been around only two or three years, “that fueled itself,” Pearce said. “The more that got out” as public companies, the more that were conceived, he said.

The venture industry, like a number of other fields, had a herd mentality at the time, said Roman Kikta, managing partner of the Addison venture firms Mobility Ventures and Genesis Campus. “VCs were throwing money blindly,” he said. “There was a sense of urgency that you had to do something. What people ended up doing was cutting corners and not taking care to do proper due diligence.”

Some venture capitalists allowed their business decisions to be swayed by their emotions, Kikta said. In addition, VCs simply made too many investments. “It’s impossible to be an effective manager when you’re managing such large portfolios,” he said.
Fewer horses in the race

By and large, most venture capitalists and analysts agree that VCs did not do their best work during the tech and telecom bubbles. The question, however, is how much money the industry should be putting to work now, especially in North Texas, where venture financing has been relatively scarce for years.

One school of thought holds that venture financing is appropriate only for a small number of companies. For instance, venture capitalists funded several online sellers of pet food, a low-margin business. “You need fewer horses in the race,” Pearce said. With VCs funding me-too companies, “the market couldn’t differentiate between the businesses.”

‘It just isn’t what it used to be’

In addition, he said, startups need to use their capital efficiently, a lesson driven home by the technology and telecom busts. The good news, Pearce added, is that technology tools have improved to the point where it’s economical to create and build things that might not have been feasible for a startup 10 years ago.

“It’s a great time to build a tech company,” he said. “You don’t need as much money.”

The flip side, experts say, is that there isn’t enough equity financing for startups to tap. “The venture capital industry in North Texas just isn’t what it used to be,” said Bill Sproull, president and CEO of Richardson’s Metroplex Technology Business Council.

Sproull noted that alternative sources of financing for early-stage companies have cropped up, ranging from wealthy individuals to the Texas Emerging Technology Fund. But, he said, “there hasn’t been a resurgence of well-capitalized venture capital groups in North Texas that can provide equity” for fast growth.

Sproull said that he wasn’t throwing stones at local VCs: “This is a nationwide problem.”