A More Strategic VC Market Benefits L.A. in Long Run.

IT'S back to basics for the Los Angeles venture capital community. Forget the first to market" hype. Today, VCs are looking for companies with a strong management team, proprietary technology, defined market and solid revenue.

In the wake of dot-com failures, venture capital firms have called time out. Now they are taking a step back to reconsider and reinstate their basic investment strategies.

The new venture capital mentality presents great opportunities -- and challenges -- to L.A. businesses. To project what's in store for L.A.'s venture capital environment this year, start by looking at the challenges facing the VC industry.

Venture capital firms are sitting on large funds, and business plans keep pouring in. But local venture capital firms are short on both time and resources.

It's no longer reasonable to expect an IPO in the first year, or even any time in the foreseeable future, so VCs are investing more time, money and resources in their portfolios. In some cases, a VC firm must decide which of the investments will receive capital and which ones will be left on their own to survive. This reality has a distinct effect on how VC firms are investing their funds today.

For instance, many VC firms have narrowed their focus to businesses they understand. They're looking for companies that will complement their existing portfolio and fill holes in their portfolio companies' service areas and technologies.

VC firms are also looking to invest in the later stages of development -- a move that lowers the risk for the venture capital firm and potentially reduces the amount of care and feeding the new company needs.

Because of time and resource constraints, there will be fewer VC deals this year. But the deals that do occur will be more strategic and involve more money.

So what does this mean for Los Angeles?

A more conservative, strategic venture capital environment will benefit Los Angeles in the long run. In the short term, it presents both opportunities and challenges to L.A. businesses.

Historically, Los Angeles has raised less venture capital than its neighbors in San Diego and Silicon Valley. L.A. simply doesn't have the biotech or wireless infrastructure of San Diego, and it doesn't have the depth of technology and start-up mentality of Silicon Valley. Also working against L.A.: Its notorious freeway system, pockets of tight occupancy levels and housing shortage.

These are very real threats to L.A. because they stymie the growth of the area's talent pool. VCs in Los Angeles already perceive a lack of management talent for their portfolio companies. They cite the fact that many of L.A.'s experienced entrepreneurs have jumped up to Silicon Valley or decided to retire after a few start-ups.

But there are areas of Los Angeles that are red hot when it comes to resources. Pasadena clearly ranks high on the list, because of its proximity to research institutions such as Cal Tech and the Jet Propulsion Laboratory. Santa Monica, Santa Barbara and El Segundo are also booming.

Why? Because these areas are home to the types of companies that VCs are looking for -- namely fiber optics, life science and entertainment/technology companies.

A number of companies in Los Angeles are vying to create devices that will allow for vast fiber-optic networks in the future. In addition, the mapping of the human genome has sparked interest in the life sciences sector. L.A. is especially well suited to pursue advancements in bioinformatics -- a mix of biotechnology and computer science.

The entertainment industry is getting its share of VC attention, as well. The convergence of entertainment and technology is a compelling notion, but these companies are wrestling with how to properly develop, deliver and protect content in the new economy. VC interest should only increase as entertainment companies find compelling ways to combine content and high technology.

At the end of the day, venture capital will follow talent and opportunity -- whether it's in L.A. or not. To remain competitive, Los Angeles startups must be savvy about which VCs they approach, and how they tell their story. In the best circumstances, it can be difficult to get in front of VC firms. In 2001, it will only be harder. But a fine-tuned business plan that fits with a VC's existing portfolio will have the best chance -- especially if it's backed by a strong management team.

Venture funding has the potential to fuel a cycle of growth and innovation in Los Angeles. The question is, Can L.A. give the VC firms what they need? The answer depends on how well L.A. companies understand what they're up against -- because venture funding in 2001 is a return to the old ballgame.

Les Granow is a partner in the Strategic Finance Group of Ernst & Young's Corporate Finance practice and manages the firm's Center for Strategic Transactions for the Pacific Southwest.