Funds tighten at Southland venture capital firms; things are absolutely normal,' says Oxford Partners.

Funds tighten at Southland venture capital firms 

`Things are abnormally normal,' says Oxford Partners

As sources for venture capital funds becomes scarcer, Southland venture capitalists with money at their disposal have recently begun to sound a cautiously upbeat note.

"There are still good opportunities, even if you need to look real hard to find that diamond in the rough," said John Schauerman, vice president at Wedbush Morgan Securities, whose venture capital subsidiary, Wedbush Capital Partners, has $30 million under management.

He added there is no shortage of venture candidates, with so many small, young businesses in need of capital.

With less money chasing after those businesses, venture capitalists can afford to become more selective in the companies they finance. According to David B. Jones, general partner at downtown-based InterVen Partners, it has become a buyer's market for the first time in years, with the venture investors as the buyers.

The numbers tell the story. New investments in venture capital funds peaked at $4.2 billion in 1987. Last year only $2.4 billion of new capital was raised.

Of course, $2.4 billion, on top of a large pool of uninvested money held by funds, is not small potatoes, pointed out Chris Lewis, partner at downtown-based Riordan Venture Management. So it is not necessarily foregone that returns will immediately return to the heights attained in the early 1980s.

Still, the shroud has lifted for the more competitive funds from the gloom and doom that came with battered returns and the resulting disillusionment by institutional investors, a primary source of funds for venture capital companies.

Old-timers in the industry, in particular, seem to have taken all this in stride. "Things are abnormally normal now," said Steven Birnbaum, partner at Santa Monica-based Oxford Partners, which has been around since 1981. "It's a cyclical business, and I've seen it higher and lower than it has been," he remarked.

The boom-and-bust business enjoyed astounding profits in the early 1980s, driven largely by high tech. Before that the venture business suffered years in the dumps. Inevitably, the sky-high returns up to 1984 attracted a flood of new money. That killed returns, as the flow of worthwhile deals could not keep in step.

Lewis now believes there are signs the venture business has turned the corner as many, including his firm, have shied away from venture investments.

More fatalistically, Birnbaum sees things getting both better and worse. "The question is in what order," he said.

According to Birnbaum, the industry has historically done best when the economy is first emerging from a recession. If that holds true, it could mean a few more years in the doldrums, as many economists see the economy slipping into a recession, if it has not already.

While the past few years have been heralded as the longest period of uninterrupted prosperity in the post-war era, that has not paid off so much for venture investors because larger, established companies tend to grow during booms at the expense of start-ups, Birnbaum said.

That partly might explain the industry shakeout that has begun and may continue. Besides fund managers which have shifted their focus away from pure venture capital to other types of investing, a few firms have closed up shop. Although none of the larger firms in the Los Angeles area have yet to do so, Fairfield Venture Partners, with offices in Stamford, Connecticut and Costa Mesa, plans to wind down its existing fund, with available cash not being reinvested. Several of its partners are reportedly going into retirement earlier than they would have in better times. The remaining partners are considering starting a new fund.

In a shake-out, the victims would tend to be the newer, less well known funds, said Al Talbot, special principal at Xerox Venture Capital, based in El Segundo.

A shake-out, however, may have little impact in Los Angeles County simply because there are not a plethora of players here anyway.

That may be little solace to upstart companies here. Guy Nohra, an associate at the Costa Mesa venture capital firm Burr Egan Deleague, is to be believed. "Los Angeles is pretty dead in venture," he said. The few well-known venture firms located in the county are outnumbered by their peers in Orange County, and most of their investing activity is centered elsewhere, Nohra explained.

Others, including Jones, have a more roseate outlook, seeing the whole area as underserved by local firms.

The surviving funds are not all, in any case, rushing to do deals. In fact, some fund managers still have pools of uninvested funds. Wedbush, for example, has yet to invest roughly half of the $30 million it raised two years ago, Schauerman said.

Those who are not sitting on such cash may have trouble raising money from institutional investors, who have become impatient not only with lower returns but also more elusive liquidity of venture funds.

"Liquidity" in the venture business refers to when the investor can cash in part or all of his investment, either through a sale of the investment or an initial public offering.

The fall-off in initial public offerings has meant "a lot of funds are not churning their investments over fast enough," Talbot said. Some fund managers have adjusted their expectations accordingly, looking at a longer time frame than three or four years they might have once set.

The desire for more liquidity has also fueled the shift to later stage investments, since these investments tend to pay back cash sooner, Talbot noted.

Yet as critical as the overall economic environment is, ultimately the venture industry's fortunes are tied to the rise and fall of new industries.

The heady days of the early 1980s owed much to the emergence of the personal computer and software to go along with it.

As would be expected, some firms have positioned themselves to concentrate on the industries they believe will produce the next Apple Computer or Lotus.

Birnbaum, for one, has launched a biotech fund, which has a target of raising $50 million by the end of the year. He predicts biotechnology will supplant the chemical industry in many areas, including agriculture, food processing, automobiles, fabrics, housing and pharmaceuticals. "I see biotech one day creating a shirt fiber with the absorbency of cotton, the luster of silk, produced with a coating that makes trips to the laundry unnecessary."

He also forecasts the nascent field will eventually become de-coupled from health care as it matures. "Electronics was also tied to avionics in its early stages because defense subsidized early research before other applications were found," he explained.

Another area generating widespread interest is the environmental field, yet few have so far committed themselves. Burned in the past with environmental investments, some see it as a business all dressed up with nowhere to go. "The perception is that environmental is hot, but the reality is that I don't know of many making deals in it," Nohra said.

That may change. It is rumored that Brentwood Associates, the second-largest firm in the area, is considering starting up an environmental fund.

Although few predict a return to the hey-day of high tech, it may be premature to write an obituary on the high tech start-up, according to a number of venture capitalists. Newport Beach-based 3i Ventures is just one firm maintaining a high-tech focus. "There is less competition as many have moved away from high tech, and that means there are fewer companies chasing deals," said John Ulrich, senior vice president of 3i Capital, an affiliated company.

3i Ventures, along with a select group of other companies, enjoys an advantage in not being answerable to institutional investors. Its funds come from a London-based corporate parent, 3i Corp., allowing it to stick it out when an industry falls out of favor.

Other areas of focus are all over the map, including medical, consumer electronics, telecommunications and retailing.

All these areas of activity may not make life easier for the entrepreneur with no more than an idea which needs seed capital. The definition of the venture business has become murky in recent years, with venture firms branching out into leveraged buyouts and later stage financings.

Although the drop in leveraged buyout activity has some fund managers looking at the venture side with renewed interest, they may well focus on later stage investments, which carry less risk.

Others have chosen to pursue the workout and reorganization business generated by LBOs gone sour.

"A lot of people will have trouble getting a start unless they have a rich uncle," Nohra said.