Venture Capitalists Exit the Dot-Com Freeway

E-commerce has hit a dangerous curve because the venture capitalists who were driving it have found the freeway off-ramp.

According to the National Venture Capital Association, venture capitalists have decreased their investments across the U.S. a whopping 31 percent from the third quarter to the fourth quarter of 2000. In contrast, for the previous seven quarters, venture capital investments had steadily increased.

Has the well suddenly run dry for startups with a digital dream?

Maybe. In fact, some industry observers say Q4's numbers were only the beginning, that this year will see a steady decrease in the amount of venture capital pledged for e-commerce companies.

Fast Track

The premise of venture capital has been sorely tested online. Venture capital is considered a high yield investment vehicle that offers cash to startups with exceptional growth potential.

While there is always a risk inherent in such investments, once the risk begins tipping the scales away from a promise of high returns, logic dictates that investors will retreat.

Venture capitalists are different animals than other investors. Decisions about where to invest are often made on a fast and furious basis. Once the momentum begins, VCs expect the returns to materialize more rapidly than other investments.

Sticking Point

The return on dot-com investments didn't come as quickly as the VCs want. It's not that the investors didn't stick it out longer than some said they would. In 2000, the Association said venture capitalists put up US$103 billion, 73 percent more than in 1999.

But when the shakeout hit, causing numerous dot-com failures, investments began to dry up. Without some unexpected gift from the commercial and industrial heavens, we may never see a year like 2000 again, when venture capitalists invested mightily in 5,380 online companies.

Slow Lane

The dynamic nature of venture capital online investing has not come to a halt, but it has slowed. Chances are that smart investors may now shift their strategy to second round funding of companies that have lived up to their self-initiated hype.

The principal players in startups show their inexperience when they express some sense of entitlement to venture capital funding. Where did anyone get the idea that venture capital was just simply there for the taking?

Now that business-to-consumer e-commerce is showing itself to be somewhat iffy, it's time for newcomers to use their wits and their connections to get their businesses off the ground.

Driving Forces

Of course, innovators have had to get creative with startup funding in the past. Look no further than women-owned brick-and-mortar businesses, which traditionally in this country have had to struggle to find financial backing.

The next time you bite into a Mrs. Fields cookie, think about Debbie Fields, who launched her now world-famous business on a shoestring, with private funding and one location in Palo Alto, California. There were no venture capitalists willing to back a young mother with no business experience.

Today, Mrs. Fields has over 650 domestic locations and over 65 international locations in 11 different countries.

Likewise, independent filmmakers have shown much creativity in their drive to finance new movies. For example, award-winning writer/director John Singleton maxed out his own credit cards to pay for "Boyz N The Hood," which ultimately won him Academy Award nominations for writing and directing and launched his career.

Promise Land

The idea of e-tailers finding their own funding without turning to venture capitalists is ironic in that once venture capitalists see a promising track record, they want in on the action.

By that time, savvy e-tailers may not even need venture capital. Just ask Patrick Byrne, chief executive officer of Overstock.com, a company that buys excess inventory from e-tailers who are going out of business, and then sells the merchandise at clearance prices. Byrne has yet to accept one dollar in venture capital money.

Why? Because he was clever enough to anticipate the dot-com shakeout and the massive inventories that would be up for bid when e-tailers bit the dust. Byrne had a better idea, and managed to launch it independently. Even now, venture capitalists want in, Byrne says no.

Alternative Ways

The venture capital gravy train is history. Those who want to get a new online business up and running now will have to find alternative financing.

That may include personal savings, money borrowed from family and friends, second mortgages, stock options, adventurous partners or alliances with existing companies.

Chances are, those who are willing to take their own financial risks will manage their money more carefully, spend wisely and create business models that show some ingenuity.

What do you think? Let's talk about it.