Silicon Valley Start-Ups See Cash Everywhere
Through 'Pre-Emptive Financing,' Venture Capitalists Shower Firms With Cash, Stake an Early Claim By REBECCA BUCKMAN March 20, 2006; Page C1
The market for high-technology start-up businesses is so intense in Silicon Valley that some companies are being showered with millions of dollars from investors -- without even asking for it.
It is a phenomenon called "pre-emptive financing," and it has become more common in the past several months.
The question is whether venture capitalists are moving too quickly, funding risky, untested start-up businesses -- just as they did during the heady, and ultimately unsustainable, technology-stock boom of 1999 and 2000.
Pre-emptive financing happens when a venture capitalist seeks out a promising start-up business and offers it money out of the blue, before the company tries to raise a second or third round of cash. If the offer is good enough, in theory, the venture investor will snag a piece of the company quickly, thus avoiding a costly bidding war that could erupt later once the company says publicly it is looking for cash and attracts several suitors.
Such bidding wars are increasingly common these days and have pushed up prices investors pay for stakes in some start-up companies. The median valuation of venture-funded start-up businesses -- the amount investors think these companies are worth -- soared to $15.2 million in 2005, from $10 million two years earlier, according to research firm VentureOne, a unit of Dow Jones & Co., which publishes The Wall Street Journal. Venture capitalists typically take stakes in small, private-sector companies, hoping for a payout later through a company sale or an initial public offering of stock.
The trend puts many start-up companies in the driver's seat. "I've had several [venture-capital] firms come to me long before we were looking for money," says Jason Goldberg, chief executive officer of Seattle online job-search concern Jobster Inc. His company, after getting unsolicited calls from two venture firms last year, raised $19.5 million in additional financing much earlier than it had planned. Young companies in wireless communications, computer games and consumer Internet services are big targets for pre-emptive funding calls these days.
It all highlights how desperate some venture capitalists have become to find homes for the huge amounts of cash they have raised, and how few companies there are that really deserve their money. Last year, venture-capital firms raised $25.2 billion from investors, the most since 2001, and they are struggling to put all that money to work.
"There's such a dearth of very high-quality opportunities," says Michael Greeley, a general partner with IDG Ventures in Boston. "Investors will move very aggressively right now." IDG has hired a recruiting firm to set up meetings between IDG partners and promising start-up executives, he says, to help his firm develop relationships and, in some cases, possibly pre-empt the process of formal fund raising.
Some investors are so eager to one up each other that they don't even bother to find out who to call at promising start-ups. A Pasadena, Calif., home-improvement Web site, Done Right, operated by a company called Perform Local Inc., received an email in January from a well-known investment firm inquiring about putting cash into the company. Paul Ryan, Done Right's chief executive officer, says the missive wasn't sent to him or to his executives -- it landed in a general corporate email inbox. Mr. Ryan wasn't put off by the impersonal plea: "We're having very good discussions with [the firm] right now," he says, declining to name the potential investor.
The risk of pre-emptive financing is that investors are so eager to seal deals early that they will overlook flawed business models and management and invest imprudently. The trend "absolutely harkens back to the bubble days" of 1999 and 2000, says Tom Blaisdell, a general partner with DCM-Doll Capital Management, Menlo Park, Calif. Mr. Blaisdell and others note pre-emptive funding has its upsides: If venture capitalists can offer financing before anyone else, they sometimes have more time to investigate a company's business and work with it to come up with mutually favorable investment terms. Many investors say the start-up market isn't as frothy as it was in the bubble, with sentiment tempered by the lethargic market for start-up initial public offerings of stock.
Indeed, not all venture firms are embracing the practice. Still, many start-up companies are leveraging pre-emptive funding calls into even more money.
Jobster, which does business with Microsoft Corp. and Cisco Systems Inc., raised $8 million from two well-known venture-capital firms in 2004. Just a few months later, Mr. Goldberg, the CEO, received unsolicited calls from two other firms offering him more money, and at terms that valued the company much more richly than had its first two investors, Ignition Partners and Trinity Ventures. Mr. Goldberg declined to name the two new firms that contacted him.
Those calls got him thinking that perhaps he did need more funding. So Mr. Goldberg called another venture firm, Mayfield Fund, which had expressed interest in Jobster months before but hadn't invested. Mayfield wound up leading the $19.5 million round of funding in August; the two pre-emptive cold-callers didn't get a piece of the deal.
"Nothing gets a VC moving like the idea that someone else might get their deal," Mr. Goldberg says. Mayfield Managing Director Allen Morgan says he isn't surprised top-drawer start-up businesses like Jobster are getting pre-emptive offers. "We're all hungry for returns," he says.
Other start-up companies also are benefiting. Gibu Thomas, a co-founder and CEO of Sharpcast Inc., which makes software that helps people access, share and back up digital content between various electronic devices, says he struggled to raise money for his start-up company in late 2004 and early 2005. But last August, Sharpcast snagged $3 million from two firms, Draper Fisher Jurvetson and Selby Venture Partners, and two months later, other venture capitalists clamored to put more money into the company.
Greg Gretsch, a managing director with venture firm Sigma Partners, visited Sharpcast after hearing about it from an engineer who worked there. When Mr. Gretsch asked if the company was thinking about fund raising, Sharpcast executives said they had just raised money and weren't looking for more.
"I'd like to do a pre-emptive round," Mr. Thomas recalls Mr. Gretsch saying. Adds Mr. Thomas, "I didn't even know what a pre-emptive round meant."
He does now. Sigma recently signed on as the lead investor in a new $13.5 million funding round for Sharpcast, an investment that valued the company at a price more than three times its valuation in August. Sharpcast says Mr. Gretsch says he was so impressed with Sharpcast that "I was motivated enough to jump through hoops and do a deal with them fairly quickly" at a rich price.
Sharpcast's product won't be launched until the spring, Mr. Thomas says.
Write to Rebecca Buckman at rebecca.buckman at wsj.com
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