Will next spring bring a thaw in the tech investment winter?

by Niki Panourgias
21 December 2001

The first year of the new millennium has turned out to be an annus horribilis for all those associated in one way or another with technology investment, from entrepreneurs and investors to analysts, developers, designers, journalists, and even PRs.

It has been interesting as well as a painful, however, and despite the thrills and spills most have been through, there is a feeling that it may have been worth it if those who make it through to the other side are wiser and learn from the experience.

“It is a good time if you like business”, says Lucy Marcus, CEO of Marcus Consulting who has recently been selected as one of the World Economic Forum’s Global Leaders for Tomorrow.

“It is more interesting and challenging than during the boom. People have to prove their metal. The tail is no longer wagging the dog. OK, so businesses might have to run on a shoestring, but that is good training”, she continues.

In the post mortem of 2001 it is important to keep in mind that the internet, the main catalyst behind the broader technology boom of 1999, was not just a technological novelty, but a business novelty also.

Too many people spent their time trying to find a suitable historical model of an economic bubble with which to compare it, instead of trying to understand the intrinsic working and economics of a completely new phenomenon that allows the sharing of information globally in seconds.

In such circumstances it could not have been anything other than a learning exercise for all concerned and as such, mistakes – even big ones – were to be expected. The problem is that many investors have lost their nerve and restoring confidence will be a long and slow process.

“The confidence of limited partners has been shaken,” says Marcus. “Being a VC is not fun anymore for those looking to move from one trendy area to the next, following the herd. The focus now is on real people running real businesses” As a result, Marcus expects that in 2002, funds will have to start thinking of themselves as businesses, with both limited partners and investees as their customers.

At the same time, Marcus recognises that entrepreneurs have become more sophisticated and that they realise that “the world does not end at an IPO.”

The general consensus among those involved in technology-related investments and brave enough to put their head above the parapet and comment is that if there is any kind of upturn and restoration of confidence it is unlikely to be before the second half of the year.

If this happens, it is unlikely to be due to some amazing new technological breakthrough or a killer application but as a result of improved business structures and the pulling together of the many discrete pieces that comprise the technology landscape as we see it at present.

“Well-managed companies with products that cut costs, increase efficiency, or otherwise contribute to bottom-line improvement will do well,” says Francesco Di Valmarana, a partner at Digital Networks.

“It is better to have a strong management with a product that needs improvement than vica-versa,” says Di Valmarana.

Olav Ostin, managing director of ETF Group in the UK, echoes these thoughts: “The ideal scenario for most early-stage investors is to invest in companies with limited technology risk and look at the challenge to market the products.”

Ostin also believes that finding managerial talent and people who have demonstrated in the past that they can successfully run technology companies that can scale outside their own country will also be an area that venture capital companies should focus on.

“There is still a lot of cash out there for companies that can demonstrate that their business model is working,” says Ostin.

There are a couple of specific areas that a number of technology investment experts agree are likely to drive growth. Both Ajay Chowdhury, managing partner at IDG Ventures Europe, and Alex Czajkowski of Armada Partners see the launch of GPRS in 2002 as providing significant opportunities.

“GPRS is likely to be more of a move up in experience from GSM than UMTS is from GPRS and we will see some interesting services,” says Chowdhury.

Alex Czajkowski of Armada Partners is more bullish about 2002: “People will start to put the puzzle together and multi-platform applications that leverage the strengths of the web, mobile communications and iTV will do well,” he says.

Apart from the availability of GPRS, Czajkowski also sees the continuation of strong consumer spending in the UK as having the potential to even generate some general market exuberance in the second half of 2002 “that could match 1999 in some sectors,” he says, as technology infrastructure problems are ironed out, especially in broadband. “People will get their head around multiplatform and start seeing the benefits,” adds Czajkowski.

Jason Purcell, CEO of specialist corporate finance house First Stage Capital has already detected some first signs of an improvement, but is more cautious about the extent of any upturn. “2001 has been a very difficult year, but we expect the uptick in activity over the past quarter to continue into next year with a rise in funding although things will not return to the peaks seen in 1999 and 2000”, says Purcell, who expects that a key theme for 2002 will be the continued move towards backing companies with core technology as well as an increasing focus on backing spin outs from UK universities and corporates “which are the key sources of strong intellectual property”.

There are a number of other variables to take into account. “There are funds that have problem portfolios and will have to spend some time fixing them and others that were late but still have money to invest in good deal still out there,” explains Chowdhury, while Ostin of ETF Group says: “2001 was the survival year. 2002 will pan out to be a very good time for venture capital companies to invest and within two to five years of investment, venture capital companies stand to make a lot of money. The venture capital companies that invest in 2002 will be smart investors, if they have the capacity.”

Although there are some first signs of life in the market going into the new year, with the telecoms sector still suffering and IT spending still in hibernation and a lack of start-ups to take up the slack there are still significant downward pressures on sentiment that make it unlikely that there will be any significant improvement before the second quarter.

Even if there is an upturn, however, most technology investment specialists agree that it will still be harder and take longer to both raise money and make exits, while investment cycles will be longer and geared to profitability and not amazing growth.

As Lucy Marcus puts it: “It’s not sexy, but its business”.