Recession clouds hopes for cash-hungry startups

Venture cash scarce, but still available for the most innovative companies, investors say.

The semi-annual DEMO conference is all about finding the next big thing, a company that can wow the technology world while raking in boatloads of cash.

Slideshow: 11 cool tech products at DEMO

But the 39 presenters at DEMO 09 this week were under no illusions regarding the fact that they are launching new technologies in a horrible economy. Venture capitalists like to keep tabs on DEMO companies but actually investing in one is another matter these days.

"It is a terrible environment to raise money," David Hornick, a general partner at August Capital, said during a venture capitalist panel discussion.

Investing as a venture capitalist always requires a certain leap of faith, since your typical startup can't prove every claim it makes, Hornick says. In this economy, investors will be less willing to suspend their disbelief when it comes to potential gaps in a startup's business model.

Eric Tilenius of Tilenius Investments said he hasn't invested in anyone since October. Entrepreneurs have to make the shift toward "capital-efficient" business models that can be built up on a budget and provide a clear avenue toward profitability, he said.

"The macro market right now is pretty bleak, if you look at the statistics," Tilenius said. "The next 12 months are tricky. I'm sort of figuring it out day by day."

After the dot-com bubble burst, it was obvious companies like Google were ready to power ahead with great business models, says VentureBeat's Matt Marshall, who is slated to replace Chris Shipley as executive producer of DEMO at the end of this year. This time around, it's not so clear which companies are poised to be the next big thing, Marshall said in an interview.

"We're not seeing a whole lot of really promising companies with a lot of traction," Marshall says. "You have folks like Twitter and Facebook. Both of those are still trying to figure out their business model."

DEMO 09, held Monday and Tuesday in the US, wasn't all doom and gloom. Shipley kicked off the show by acknowledging the economic conditions -- nearly twice as many companies presented at DEMO one year ago. But Shipley argued that a recession, if nothing else, weeds out the pretenders, letting the cream rise to the top.

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"There is nothing like a recession to clear out the clutter," Shipley said. "[Companies] that are a little bit faster, a little bit more courageous are winning the day."

Skout, one of the 39 presenters, is dealing with the economic downturn by putting fund-raising on the back burner and focusing on building go-to-market partnerships with larger companies.

Skout offers a location-based dating service accessed through mobile devices. CEO and founder Christian Wiklund says the online dating industry tends to be somewhat recession-proof, but notes that starting any company these days has its challenges.

"From a startup perspective, of course it's going to be tougher to raise funds," Wiklund said. "You have to be more frugal and you have to more agile in how you get to cash flow as soon as possible."

The smaller number of presenters at this year's DEMO reflects not only the poor economy but also Shipley's refusal to lower the bar, Marshall says.

"There are fewer companies out there, there is less noise," he said. "Chris was keeping some discipline in how she selected companies. Just to keep to the threshold we had before of 50 or above would be pointless if you were letting in companies of lower quality."

It's clear that investors today will be most interested in ideas that require little up-front cash, but that doesn't mean a great innovation will be scuttled just because it requires a big investment, Marshall says.

"If there's a great idea, they're not going to go by the wayside," Marshall says. "The thing is, we're seeing fewer great ideas, I think."

Tarun Kalra of Battery Ventures attended DEMO but said it's too early to tell whether he'll invest in any of the 39 technologies presented at the show. Emerging technologies like cloud computing and virtualization should provide an opening to startups who can build sophisticated systems management software products, he said.

"The big IT expenditures right now are in the cloud computing and virtual environments," Kalra said in an interview. "Systems administrators and IT staff have these really advanced environments that they don't know how to control, how to provision the resources below them. This creates a huge need and a huge opportunity for big new platforms that provide functionality for systems administrators."

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Startups that can prove their products reduce cost and increase revenue have a huge advantage, Kalra says.

From the current crop of DEMO companies, Kalra said his favorites are 7 Billion People and Zuora, each of which developed e-commerce platforms; and Purewire, which unveiled an Internet security product.

"Looking at the startup landscape there are a number of interesting companies out there and a number of them are very bullish on their prospects," Kalra says.

But even in good times, the reality is a large number of new companies will simply fail. Tech investors said there are both positives and negatives to having less venture cash available. After all, the ability to raise venture capital isn't exactly the same as the ability to create an innovative, commercially successful company.

"Any time you look at the startup community you expect a high failure rate," investor Christine Herron of First Round Capital said during the panel discussion. "It's actually healthy to have less capital going in and have it be more competitive for people to get funded. It's a good thing."

Hornick said having a venture landscape overflowing with cash doesn't necessarily promote an efficient market in which smart people build good ideas. Even in a down economy, there should be enough money to fund the truly innovative startups, he said.

"There will always be technology that is game changing and exciting and people say 'I want to invest in that,'" he said.