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Venture Capital—Local venture community prepares for rebound

The San Diego venture community , including the institutions, venture capital firms, investors, attorneys, accountants, entrepreneurs and others who are involved in the process of starting and financing businesses , has shrugged off the gyrations in the financial markets of the last year and is poised to enter the last quarter of 2000 with surprising confidence and vigor.

After the major sell-off in the stock market in April of this year, there was a several-month period of adjustment and caution on the part of the venture community, both here in San Diego and across the country.

Many venture capital firms were reevaluating their strategies and the important flow of seed-funding from individual investors, without which most start-ups cannot make it to the stage of venture financing.

In some cases, seed-funding slowed to a trickle. The number of initial public offerings, or “IPOs,” also dropped dramatically during the second quarter. In short, the flow of funds into deals slowed on every level of the investment chain.

As the summer months draw to a close, venture activity has begun to pick up. This is due largely in part to the fact that September not only marks the formal beginning of the presidential campaign season, but also the beginning of the IPO season.

Underwriters and investment bankers around the country traditionally use the long Labor Day weekend to finalize their plans for September road shows, in which IPO-bound companies make presentations to underwriting syndicates nationwide. How the September IPOs fare may well determine how the whole season goes.


– Money Flows In Nationally

Money is flowing into deals at a better than respectable pace on a national basis, and San Diego companies will share in the cash.

Only a few months ago, the IPO market had all but dried up. Relatively few companies have made it out of the IPO gate in the third quarter of 2000. There are signs that this trend is reversing.

For example, there are presently more than 25 IPOs scheduled for next week. At least two San Diego companies are among these 25. How these companies fare is important to the psyche of not only the IPO market, but the entire venture community.

Past months have seen a considerable number of IPOs delayed or withdrawn. For example, of the 18 San Diego companies that filed for IPOs in 2000, five were withdrawn. By comparison, of the 12 San Diego companies that filed for IPOs in 1999, none were withdrawn. IPO.com is a great source for information on the status of IPOs.

The IPO market sets the pace for the entire venture financing investment chain. An active IPO market provides the critical liquidity for investors. This is because generally the best and most profitable way for investors, including seed-round friends and family, angel investors and venture capitalists, to sell their stock is if the company is able to go public in an IPO.

Thus, a healthy IPO market encourages investment all along the investment chain. To get going, most companies need to attract initial seed-funding from an inner circle consisting of friends, family and high-income investors.


– Tables Turning After Spring Slide

After the April slide in the markets, many start-ups in the earliest stages of financing experienced trouble raising money. This has changed, and most deals now are attracting sufficient seed-funding to move on to the “angel” or venture capital rounds.

As has been reported recently in the San Diego press, venture capital investments in San Diego companies nearly tripled during the past four quarters.

The numbers are truly impressive: VCs invested $1.357 billion in San Diego companies in the last two quarters of 1999 and the first two quarters of 2000. By comparison, the prior four quarters totaled only $484 million.

The San Diego Regional Chamber of Commerce published an excellent summary of this data in its August Economic Bulletin.

Venture capital investment in San Diego companies presently ranks 13th in the United States, according to the PriceWaterhouseCoopers “MoneyTree” Report.

VCs invested $332 million in 39 San Diego companies during the second quarter of 2000. To put this in perspective, the Silicon Valley ranks No. 1 with $6.8 billion in VC investments in 408 companies during the same period, and Los Angles/Orange County ranks eighth, with nearly $1 billion invested in 69 companies. Considering the differences in population and geographical area, San Diego is doing quite well compared to the rest of California.


– Positive Outlook For Local Growth

Most importantly, there are a number of factors why VC investments in San Diego companies will likely continue to grow. First, San Diego’s biotech and wireless industries are well developed and the software industry is thriving. In addition, the cost of doing business in the Silicon Valley is extreme, making San Diego a bargain for start-up companies.

According to The Wall Street Journal, the off-the-chart costs of Silicon Valley are driving the major investment banks, including Merrill Lynch, Bear Stearns, and Goldman Sachs to expand their operations in Los Angeles.

This trend can only help San Diego as the major investment banking firms provide the access to the IPO market for start-up companies. Growth in the investment banking sector in Los Angles and in San Diego thus provides enhanced access to capital for San Diego companies, which in turn strengthens the entire investment chain, including seed-round, angel and venture capital investing, due to increased liquidity.

No doubt we will see continued volatility in the financial markets. But in the final analysis, the global economy depends on the creation and growth of new business, and San Diego is poised to continue to take advantage of this trend.

Jones is a venture development and securities lawyer with Higgs, Fletcher & Mack LLP of San Diego and founder of the firm’s Start-Up Law Center.

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