Recession has a domino effect on venture capital

Call it a trickle-down effect, but not the kind President Reagan would have liked. The recession has cost most institutional
investors, such as university endowments, about a quarter of their value. As a result, venture capitalists’ primary source
of funding has dried up. The implications for Hoosier entrepreneurship are stark.

"Right now, it is very difficult to raise a dime," said John S. Taylor, research director for the Arlington, Va.-based
National
Venture Capital Association. "It could be an icy couple of years."

With less money available at the source, professional venture capitalists are hanging on to what they’ve got. And their priorities
are changing. Rather than take risky bets on promising new technologies, VCs are hunkering down, trying to make the most of
what’s already in their coffers.

For innovative local startups that raised venture capital during the last few years, the
days ahead will be all about meeting stricter and more frequent benchmarks before they’ll get any more cash.

But for neophyte high-tech pioneers, the days of funding for back-of-the-envelope business plans are over—especially if the
path to profitability isn’t quick.

"People will be more satisfied with smaller gains on a shorter basis. [They] want to get back at least some of what they
lost.
They’re not going to be patient," said former Indiana University Research and Technology Corp. President Mark Long. "It
will
be a tough row to hoe for a while."

Consider John Rice, managing director of Cincinnati-based Triathlon Medical Ventures. In January 2008, his firm led a $6.3
million investment in locally based cancer diagnostics startup CS-Keys Inc., where he’s a board observer. It was Indiana’s
largest venture deal last year.

If the deal were even possible today, it likely wouldn’t be on the same terms. Since the recession began, Rice said, entrepreneurs
have given up more of their businesses in exchange for less venture investment. So firms like CS-Keys
now must dig in their heels.

"I’m glad we were able to put money in the bank in advance of the downturn," Rice said. "Every VC has talked
to every one
of their portfolio companies with regard to their burn rate and priority of programs, trying to stretch cash longer.

"People joke that flat is the new up."




Broad pain

Although the recession began more than a year ago, the extent of its damage to college endowments is only starting to become
clear. Many universities don’t publicly update their endowment values until June 30, the end of their fiscal years. The worst
effects of the economic downturn occurred after that.

A survey of 235 higher educational endowments by Commonfund, a Wilton, Conn., endowment money manager, found an average loss
of 24.1 percent from July 1 to Dec. 31 last year.

Purdue University’s endowment contracted 28.6 percent, to $1.4 billion, in the final half of the year, said James Almond,
interim executive vice president for business and finance and treasurer.

That meant Purdue’s allocation to venture capital shrank proportionately to just $43 million. The university devotes 9.2 percent
of its endowment to private equity investments, with about one-third of the private equity earmarked for venture capital.

"What we’re trying to do is have a well-positioned and diversified portfolio, because it’s really difficult to predict
how
any sector will do," Almond said.

Compound that phenomenon across universities nationwide, and consequences for innovation become clear.

"All of them were seeing similar declines in value," said John Walda, CEO of the Washington, D.C.-based National
Association
of College and University Business Officers. "Everybody across the board is feeling the pain."

Some universities, particularly private ones, rely heavily on endowment income to help pay for operations. Those are the schools
where endowment losses are having the most impact on tuition rates and cuts in the classroom, said Walda, who took the post
after directing federal relations for Indiana University.

Venture capital will remain an important piece of university endowments. But he said universities are likely to step up scrutiny
of venture capitalists, requiring more disclosure than before.

"I just think a lot of investment managers, if they are unable to find enough information that makes them comfortable
that
they know the true value of an investment, they’ll avoid it in the future," Walda said. "That didn’t always happen
in the
past."

Due to the credit crunch, even top venture capital funds are having trouble raising money, said Taylor, the venture association
leader.
Only funds with returns in the top quarter of the industry are able to gain traction. And forget about funds with no pedigree.

That’s why VCs are hanging onto the money they previously raised, Taylor said. They don’t know when they’ll be able to get
more.

"When VCs are making investments now, they’re reserving a lot more for follow on," he said.

But it’s increasingly difficult for VCs to access even the money they’ve raised. Institutional investors like university endowments
usually don’t shell out all the cash they give VCs upfront. Instead, they wait for "capital calls" when the VCs
actually put
the money to work in startups.

Baker & Daniels partner Charles Schalliol said stock market losses have prompted institutional investors to informally
ask
VCs to delay capital calls whenever possible.

Schalliol formerly managed Lilly Ventures, Eli Lilly and Co.’s $175 million venture capital fund, and was a main architect
of the $73 million Indiana Future Fund, which was started by BioCrossroads, the not-for-profit that promotes life sciences.
Schalliol also played a major role in launching the $155 million Indiana Investment Fund, backed by Indiana’s largest public
pension funds.

"Some major funds are saying, yes, you have the right to call capital. But because my portfolio is down so much, if you
call
me, I’ll have to sell things I don’t have to sell at bad prices," Schalliol said. "So please, Mr. VC, don’t make
a capital
call.

"This puts the VC in a horrible position."

The upshot: Entrepreneurs are relying more than ever on angels, or wealthy individuals. Long, who now runs his own business
incubation consultancy Long Performance Advisors, said angels have lost plenty of money, too.

But they’re far more willing to fly by the seat of their pants than university endowments.

"A lot of people thought the angel market would disappear, but we’re finding angels more approachable because they’re
trying
to make back the gains they’ve lost," Long said.