There is clearly a shakeout happening in the venture capital business. Because of the global financial collapse, a shortage of returns and the lack of an IPO market (two in the last week notwithstanding), new funds have become very hard to raise. But if you ask any venture capitalist, they will say that business is “as usual” and that they are looking for new deals. The dirty secret is that many venture capital firms are only looking at supporting some of their existing companies and will not invest in new deals, but will still take your call, let you stay up all night preparing your presentation and doing your research, and let you schlep up to see them and make your pitch. Why will they waste their time and yours pretending to do diligence on new deals? Because venture capitalists are like sharks in one significant way: if we stop moving, we are dead.
If a venture capital firm were to say that they are not investing in new businesses, they will be quickly forgotten. Word gets around and nobody will show them the new interesting deals, now or in the future. The game of venture capital is all about seeing the best deals. If a firm is the best in an area, whether geographic or vertical, it will see the best deals and entrepreneurs in those areas. As soon as the great deal flow stops (the crappy deal flow will always be there), a good firm may as well shut its doors. No firm wants to cut off the great deal flow. Even if capital is tight right now, there may always be some capital available if a deal is good enough. Also, the markets may loosen up for fund raising from limited partners and you never want to be out of the deal flow when that happens. So, it is in the best of interest of all venture capitalists to say that they are doing new deals even when they are not.
So how does an entrepreneur avoid wasting time with someone who is just looking around or trying to stay in the market, endlessly pitching firms who never say yes or no? One way is to see when a VC firm raised its latest fund and how much capital has been deployed. That can be hard figure out exactly but it is certainly best to find a firm that raised its newest fund within the last three years. The second way is to see if the VC firm has done at least two new deals in the last twelve months. If both those boxes are checked, the firm is probably still doing new deals.
We at RRE last raised a fund in 2007 and have plenty of dry powder. We have been very active on the new deal front and have a number of term sheets out right now. But we run across the same issues when looking for co-investors in deals. Entrepreneurs beware: Make sure the venture capital firms you are pitching are still swimming like sharks and not sinking to the bottom of the sea.