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Something Ventured VCs Are Asked to Give More Than Just Money By Janet Whitman Dow Jones Newswires September 4, 2002

NEW YORK -- Venture capitalists are getting a lot more requests these days to put their mouths -- and their signatures -- where their money is. With hundreds of cash-strapped companies ailing, and in many cases failing, more and more bankers and prospective customers are checking up on the health of start-ups by telephoning the fledgling companies' venture-capital backers. Although the practice was not unheard of over the years, the number of calls and the list of questions and demands have increased dramatically in the wake of the dot-com crash. Instead of simply asking venture capitalists whether they still support the companies in their portfolios, nowadays prospective customers, bankers and others with potential liabilities to start-ups want guarantees. Before agreeing to buy a product, some companies are asking venture capitalists to sign contracts vouching for their financial commitment to a particular portfolio company. Some banks, meanwhile, are refusing to provide bridge financing to struggling start-ups unless venture capitalists agree to back the loans. "It used to be that customers would call a well-known venture capitalist and say, 'Are you behind this company?' And they'd say, 'Yeah, we're there.' And the customer wouldn't ask for anything more," says Michael Herling, a partner with Stamford, Connecticut, law firm Finn Dixon & Herling. "Now, more customers are asking venture capitalists to sign on the dotted line ... agreeing to continue to support the entity for some period of time. If there's a cash shortfall, customers want to make sure there's some support for that company ... to make sure it's a sustainable supplier." Customer calls are a new phenomenon at APV Technology Partners, Palo Alto, Calif., says co- founder and general partner Spencer Tall. "Before, companies just assumed that if they got a product in that worked very well or solved some specific [need] that somebody would be backing it. Financing wasn't something that customers worried about." The pop of the Internet bubble, however, changed all of that. Massive overinvestment in the highflying late 1990s created hundreds of application-software companies, for instance, in a market that ultimately would have only enough demand to support five or six. "Companies had vendor after vendor go belly-up, leaving them with a half-installed product," says Mr. Tall. That has made prospective customers more than a little cautious when weighing whether to buy a product from a venture-backed company. Cash-burn rates now play as big a role in a sale as a must-have product. Venture capitalists are quick to point out a benefit from their increased contact with customers. The interaction often ends up in a multimillion-dollar commitment from the customer to buy a start-up's product, in many cases with no more than verbal assurances from venture capitalists that the company has at least a couple of years of life. Demands from bankers, however, have been more onerous. "What's happened a lot lately is a bank will have a loan out to a company and the covenants [will be broken]," says Mr. Tall. "In the past, bankers didn't call that loan. They'd acquiesce to the VC." Now, however, with many banks already suffering from numerous bad bets on start-ups, venture capitalists are having a tougher time convincing them to back down from calling loans. "Bankers are saying, 'Okay, but you back [the bridge loan',' " says Mr. Tall. "We did it once, but it's been proposed to us many times." Joseph Tzeng, founder and chief executive of Crystal Ventures in Palo Alto, Calif., says banks are "overreaching" by asking for written guarantees from venture-capital firms on their portfolio companies. In essence, banks are asking venture capitalists to assume another risk beyond the chunk of capital they already have invested in the start-up. "That's not our responsibility. But it's happening," says Mr. Tzeng. "Banks are extremely conservative nowadays." The concerned callers aren't limited to customers and bankers. "Landlords, attorneys, suppliers: They all want to know that the companies they are dealing with are viable," says Mr. Tzeng. Their concern, which is mainly toward, but not limited to technology and telecommunications companies, is understandable. >From January 2000 through the first half of this year, for instance, no less than 862 dot-com companies have filed for bankruptcy, according to Webmergers.com (www.webmergers.com1). Though the pace of shutdowns has slowed over the past couple of months, casualties still average about a dozen a month, show data from the San Francisco research firm, which has been keeping a tally of shutdowns. The turbulent times also have venture capitalists themselves taking a more proactive approach when it comes to potential business for their start-ups by calling prospective and existing customers. "We really do need to know that customer traction is there," says Mr. Tzeng. "To a certain extent we called customers in the past, but now it is almost a mandatory item. Every dollar is precious now." Write to Janet Whitman at janet.whitman@dowjones.com2

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