Editor’s note: In partnership with Local Tech Wire, Raleigh Metro Magazine has just published its third annual High-Tech 100 issue, focused on the technology industry in and around Research Triangle Park. In the second of a series of exclusive, online stories, LTW takes a look at the state of venture capital.

“It’s a very difficult environment because of all of the political and market uncertainties. Anyone who is more than cautiously optimistic about the future these days needs to have his head examined.” — Max Wallace, president and CEO of Cogent NeuroscienceThe current climate for venture capital investments is rapidly being transformed into a national limbo contest: How looooow can you gooooo?

Despite recording the third-largest year for venture investments in 2001, the amount of money being pumped into technology and life sciences startups has been on a fairly steady downward trend since the dot-com boom went bust two years ago. From a high point of $29 billion in the first quarter of 2000, venture activity has tumbled almost 80 percent, to $6.2 billion in the first three months of this year.

The same is true for North Carolina, which saw just 14 venture deals for a combined $64.6 million during the first quarter, according to the MoneyTree Survey compiled by the National Venture Capital Association, accounting firm PricewaterhouseCoopers and research firm Venture Economics. That marks the lowest quarterly total for the state in three years and puts the state on a pace for its smallest annual total in five years. Figures rebounded a bit in quarter two, and a burst of deals in August sparked some hope of renewal, pushing the state’s total to $314 million. Georgia firms, meanwhile, have raised more than $400 million. Not bad, but the overall outlook remains grim.

“It’s hard to tell when we’ll see the bottom of this,” says Jeff Barber, who heads the Carolinas technology practice for PricewaterhouseCoopers in Raleigh. “I would think that it has just got to get better soon … (but) I’ve thought that before.”

For their part, venture capitalists think things are just fine right now. After throwing money at dot-coms with flimsy business plans a few years ago, they say they returned to doing what they are supposed to do: carefully select companies with solid revenue streams for investments that should produce good returns.

“Rational” valuations

“Valuations are more rational now,” says Mitch Mumma of Durham-based Intersouth Partners, North Carolina’s largest venture firm. “A good company will always get funded, and everybody is out there looking for those companies.”

Entrepreneurs like Max Wallace, on the other hand, are looking for money. The president and chief executive of Durham-based drug discovery company Cogent Neuroscience, Wallace has been working hard for almost a year trying to raise up to $25 million to finance the company’s growth.

“It’s a very difficult environment because of all of the political and market uncertainties,” says Wallace, who adds he hasn’t seen an investing cycle as depressed as this during his decade-plus of work with startups, which include Sphinx Pharmaceuticals, Trimeris and Sarco in addition to Cogent.

“Anyone who is more than cautiously optimistic about the future these days needs to have his head examined,” he says.

The venture industry values experienced management almost as much as a nifty new idea, so if a successful veteran like Wallace can’t obtain funding in the current environment, what can a startup do to keep itself alive until the economy picks up and venture firms turn on the investment tap again?

Days of ‘dot com’ flash are over

Entrepreneurs and venture capitalists alike say now isn’t the time to be flashy. Play it close to the vest, trying to do as much as possible with as little money as possible, and focus on lining up customers and generating revenue, they say.

Scot Wingo, president and chief executive of Morrisville-based software developer ChannelAdvisor, says he and business partner Aris Buinevicius did just that with their first company, Stingray Software, in the mid-1990s. The pair paid their own way while building a business that they later sold for $21 million.

“You can do it without outside funding, but you have to be focused on getting your product to market quickly,” Wingo says. “You have to plan well, you have to put in a ton of sweat equity and you have to get a little lucky now and then.”

ChannelAdvisor has used venture money on its growth path, including a $5.7 million round raised early this year.

Vivek Wadwha, another experienced entrepreneur who is chief executive of Cary-based software developer Relativity Technologies, says startups need to sell their idea – and whatever product they can get out – to anyone and everyone before pitching themselves to a venture capital firm.

“You learn very fast what the market wants and can adjust as needed,” says Wadwha, who has been trying to find a market for Relativity’s programs for a couple of years. “Most of the dot-coms got their money first and asked questions later, and that’s why they failed.”

Wallace says entrepreneurs should try to build firms that don’t require a huge investment. That usually entails bringing in venture capital from the Northeast or the West Coast, he says, and imported capital is becoming increasingly rare.

“You have to build an architecture that is more sustainable with local (venture) sources,” he says. “In a more robust environment, you didn’t need to plan past the A and B (funding) rounds because things usually took care of themselves. Now, you need to have not only more long-range vision but more certainty in that vision as well.”

Looking for the sure thing

Certainty is one thing venture firms crave now, after getting burned badly by dot-coms that blazed across the late-1990s sky only to crash in the past year or two.

Rather than making bets on new companies, most of them have been sticking with companies already in their portfolios, investing in follow-on rounds that they hope will push the companies far enough along that they will be in position for a sale or public stock offering whenever the markets rebound. The firms also are searching for safety in numbers, teaming up more often in large deals that spread risk around or flocking to the latest investing trend: biotechnology deals.

“You have to make sure there’s enough money around the table so the company can make it farther down the line and might not need to come back for another round later on,” says Mumma of Intersouth.

Aurora Funds of Durham, one of the largest and most active venture firms in the area, is among those focusing more on biotechnology investing. Scott Albert of Aurora says the potential for a high return is better in the biotech sector than in information technology because few companies are buying software or telecommunications equipment now.

“You have to wait for the next big change in IT that will create the need for new products,” Albert says. “That’s when the returns will improve and investors will be interested again.”

Intersouth and Aurora are among a number of venture firms still willing to invest in North Carolina technology companies – although on their own terms. Here’s a look at some other firms that actively invest in the state with a good degree of success:

  • Academy Funds of Charlotte provides seed funding for companies built around technology that comes from university research programs statewide. The firm is putting together a $175 million fund to expand that focus to six other Southeastern states.
  • Cordova Ventures of Atlanta is among the most diversified investors in the Southeast, with holdings from technology to real estate. Triangle tech companies are a primary target for its capital, with nine in its portfolio.
  • Eno River Capital of Durham manages the N.C. Biosciences Investment Fund for the N.C. Biotechnology Center, so it has a good handle on promising biotech startups in the area. It also is very active in community development groups around the Triangle.
  • Gray Ventures of Atlanta is an angel investor fund that gets out of town often to focus on Triangle deals. It has nine area companies in its portfolio.
  • Kitty Hawk Capital of Charlotte is the state’s oldest venture firm, having been founded in 1980. Its fairly conservative philosophy has kept the size of its fund and its investments from the inflated levels seen elsewhere, but its losses have been few as well.
  • Noro-Moseley Partners of Atlanta is the Southeast’s largest venture firm, managing almost $600 million. North Carolina has held a special place in its investing heart for a number of years, with 14 Tar Heel companies in its portfolio.
  • A.M. Pappas & Associates of Research Triangle Park has the largest fund in the region devoted to biotechnology deals. Chief Executive Art Pappas is a former Glaxo executive with connections worldwide that he puts to good use to find the best investments and build his portfolio companies.
  • Southeast Interactive Technology Funds of Durham is the region’s largest firm focused on IT investing. It had some high-profile losses among the dot-gone crowd but recently reloaded with $100 million and brought in a Wall Street veteran to help make later-stage deals from which it can exit.
  • Tri-State Investment Group of Raleigh is North Carolina’s largest angel investor network, with about 100 individuals putting $30 million into four investment pools. It often provides some critical early financing to companies not yet ready for venture cash.
  • Wakefield Group of Charlotte is the private investment vehicle for the family of drywall tycoon and former University of North Carolina President C.D. Spangler. It is managed by a group of former investment bankers and entrepreneurs.
  • For more details on these firms, including contact information, see list:

    VC Watch: The Top 12 Firms www.localtechwire.com/article/cfm?u=1885&k=13&I=01

    Monday’s story: Top Executives To Watch: www.localtechwire.com/article.cfm?u=1870&k=13&I=01