In a sauna an hour north of Helsinki, 30 venture capitalists are locked in intense discussion. The VCs are all telecoms industry specialists from 3i’s 16 offices around Europe, but in some cases they are meeting for the first time. Their ‘away day’ has been organised to address a critical issue. Amidst universal economic weakness, and with the telecoms sector in the doldrums, many of the companies they have funded – even the ones creating highly innovative and valuable technology – are struggling to make headway. The VCs are there to pool their collective expertise, work on synergies between their investments and share their networking contacts.

Later, over a beer, Ere Kariola, the Finland-based head of the telecoms team, tries to tackle a problem encountered by a colleague who is trying to help one of his investment companies find an inroad into Nokia. Kariola pinpoints just the right set of individuals within the mobile phone company’s 10,000-strong R&D group – people who are looking to license technology in that area. Internal Nokia telephone numbers are scribbled on a beer mat.

On the other side of the Atlantic, a group from Crescendo Ventures is helping portfolio companies in an equally practical way. The VC company has organised a week-long tour of 15 potential partners and prospective corporate customers in the Minneapolis area – all for the benefit of Alan Cornwell, the CEO of digital rights management software company, SealedMedia. The UK-based company’s technology may be highly rated, but without the VC’s clout, Cornwell would have little chance of getting through those doors.

Such activity has often been advertised by VCs keen to close a deal, but in practice it has rarely been delivered. But as early stage companies “go through Death Valley” (in the words of Kariola), VCs are becoming much more active in the support they extend to their portfolio companies.

Their involvement is certainly selective, however: they tend to pick and choose which companies are solid prospects – those that they think are worth helping through the technology industry recession.

That support also takes many forms – over and above keeping companies fuelled with cash, it includes extended counselling on strategy, direct participation in the start-up’s board, increased matchmaking with key partners and customers around the globe, and even the marketing of the investment vehicle and its technology.

Some VCs are proving more effective at this deeper involvement than others; but they all know that for some of the companies, such backing will be instrumental in their survival.

“In the good old days, VCs would be relatively passive investors,” says Martin Lambert, CTO of SealedMedia. “VCs have now gone back and reassessed all of their portfolios to make sure the companies that really ‘have the legs’ survive the economic meltdown. My impression is they are going to do everything in their power to make these companies successful before they even think about getting back into any new, expansive deals. We have seen a radical improvement in the focus we get from our investors.”

His experience is shared by many. Mike Quinn, CEO of supply chain collaboration software company Eqos, has also benefited: “Over the past year we have had a lot more positive and active support from our VC partners, Advent and 3i. The company chairman, Lee Tate, a 3i nominee, and Nick Teasdale, Advent’s representative on the board, have helped to guide Eqos through a series of restructuring and operational changes, cutting its overheads through the disposal of unnecessary office facilities and establishing tax credits on its R&D spend. “[That is] stuff that requires lots of grey hair and practical experience,” says Quinn.

Eqos is showing the benefits of that hands-on involvement. Revenues for the year to September 2002 more than doubled and its costs were cut by a double-digit percentage.

The VCs themselves admit they had little choice but to change tack. “We have rejected the investment banking model, where people fly in and advise the company, then leave till the next quarter,” says Martin Gagan, head of 3i’s US West Coast organisation. Almost as a matter of course now, 3i takes a board seat at its investment companies. Of the 53 companies it is funding in the US, for example, 31 have a 3i VC or nominee at the board table.

Credibility gap

Most crucially for the start-ups, though, is the influence that large, respected VC firms – with their well-connected portfolio managers – can bring to bear in the market. This is of paramount importance when the volatility of the technology sector encourages decision-makers to look to large, stable suppliers rather than cutting-edge start-ups.

According to Quinn at Eqos, VCs are playing an ever more essential role in establishing the company’s credibility and sustainability in the eyes of both systems integrators and customers.

“When dealing with a venture-backed company, what is important to these partners and customers is the endorsement given by the investors,” says Quinn. “The VCs underpin these partners’ confidence in the business,” he adds. In the case of Eqos, the company’s flagship account with supermarket chain J Sainsbury, signed in September 2001, was only sealed after 3i’s board nominee, Lee Tate, was brought in to add credibility to the company’s involvement with systems integration partner Accenture, the lead company on Sainsbury’s supply chain project.

Lambert echoes the sentiment. “The blue chips want to know if we are going to be around in six months’ time. So the VCs are often called on to assure them we are not going away,” says Lambert.

But that only works to good effect for the larger, better-known VC companies. “One of the chief value-adds we can bring is to show that the company whose technology we are recommending is high quality,” says Kariola of 3i.

Global reach

For many technology start-ups, business opportunities are not always local. That is one reason why VCs such as Carlisle, Atlas, 3i and Warburg Pincus have been establishing a global footprint, arguing that they can lend highly valuable support in spotting opportunity at a global level. “Early stage companies become globally relevant at a much earlier point than before – within six to 18 months of coming into existence,” says Ian Lobley, director of the communications group at 3i.

But not everyone has been the benefit of global reach. “In practice, I have not found our VCs’ international contacts either positive or negative. Some VCs oversell that, but we had no unrealistic expectations that they would get us into the US market, for example,” says Quinn. “What they are doing is help police such moves, to understand the real impact in a much more stringent way than before. In the past they would have naively handed over money and told us to get on a plane. And we would have naively spent it before we even had an inkling of a deal.”

Additionally, VCs are taking other practical steps. 3i, for example, plans to market the strengths of some of its portfolio companies to IT decisionmakers through a magazine, iSight. And it plans to showcase them at an IT director’s conference in Barcelona in 2003. “They are acting as an extended market and sales resource,” says Lambert at SealedMedia. “They are getting into the trenches and using their network to arrange meetings we would not otherwise get.”

The fundamental thing young companies want from VCs, of course, is still capital. But there are also changing patterns there – in its availability, structure and the frequency.

New rounds have become tortuously difficult to raise, often with less money, says Lambert. “The last round we did was the most difficult thing I’ve done in my life,” he says. “Almost all VCs have gone from believing in anything to almost believing in nothing.”

SealedMedia did manage to establish some belief, raising $16.5 million in September 2001 from Crescendo and 3i.

But in other cases the experience has been more of a drip-feed of money as VCs try to minimise their exposure. “CEO and CFOs of entrepreneurial companies are spending a large proportion of their time raising new rounds of financing. And when they do get the funding, they are only getting a small chunk, to keep them going for six months or a year,” says Steve Harmston, director of European research at VC market watcher VentureOne. That is not an efficient model for either side, he adds.

Cost of money

VCs are also getting a lot more equity for their money. “The cost of money has gone through the roof in terms of the equity they [VCs] take for the cash,” says Quinn. But, he adds, “they’ve helped us get our capital structure in shape so there is better value for the shareholders and still enough to motivate the team.”

“With valuations low, VCs have to be very careful,” says Lambert. “If capital is too expensive to raise, then people will not feel they can share in the success of the company.” He does not believe SealedMedia has given up so much of its equity that it cannot motive employees or recruit hot talent. But if it had to go back to the capital market again, that could be a problem.

There is no suggestion that VCs are trying to take responsibility away from their portfolio companies. That ultimately rests with the management of the business. “In businesses like ours that are doing OK, they have given more, not less, control back to us, saying: ‘Get through the tough times, you know what you’ve got to do’,” says Quinn.

What investors really want to see is a deep commitment from a portfolio company to succeed. But, says Lambert, to be sure of getting that, “the VC has to match that with their belief and commitment”.

Commitment on both sides will be the deciding factor as to which young companies emerge successfully from the current tough times.