400 active venture capital firms across the United States were surveyed by e-mail in September and October 2001, 80 or 20% of the firms responded and completed the survey. The firms were located in 23 different states, 33% located on the East Coast, 21% in California, 14% in the Midwest, 10% in the South, 6% in Washington State, and 16% in various other states. The firms ranged from small, regional firms to firms that were national in scope. The size of the VC funds varied as well. Respondents were told their specific answers would not be attributed directly to them nor that their firm had participated.

For the first time we have regionalized the results of the 2001 venture capital survey. Regions included East Coast, South, Midwest, Southwest and West Coast.

The quantitative questions asked the venture capitalists to rate their response from 1 to 5. The answers to the qualitative questions were summarized into categories. Below those summaries we have included relevant quotes from the venture capitalists in italics.

Compared to 12 months ago, has the environment for entrepreneurs looking for investors improved? Please rate from 1 to 5, 1 being much worse, 5 being much improved.

The average rating was 1.9. 81% rated the current environment as worse, or much worse than the previous 12 months, only 11% said it was about the same and 8% thought it was improved. Not a single VC gave a rating of 5.

When asked why they thought that the current environment is worse, no one explanation predominates. As one can see below, the top four reasons are reasonably close together varying only 5 percentage points. It is interesting to note that if 'no exit strategy', 13%, is combined with 'public market down/low IPO activity', 10%, the resulting combined ranking would be 23% and jump into first place.

The depth of this pessimism is rather surprising, considering that 12 months ago, September - October 2000, the public market had already declined, technology stocks had plummeted, dot.com failures were in full throttle, and IPOs were nearly non-existent.

1. VCs are focusing on their current portfolio of companies and don't have the time or resources to investigate new companies -- 18%

"VCs are bolstering their portfolio companies rather than investing in new."

"VCs are preoccupied with portfolio issues and the recessionary environment makes setting values problematic. Additionally getting funding for existing portfolio companies is still tough."

"VCs are still nursing their technology portfolios. Those of us without these problems are experiencing a good buyers market."

"Indigestion from prior deals, lack of confidence, more attention to old deals."

2. Economy/recession -- 16%

3. No exit strategy/poor liquidity markets -- 13%

3. Uncertainty -- 13%

"Extreme uncertainty"

"Given the current market and recent events, investors are much more averse to risky opportunities, and much more diligent when acting at all."

"Conservatism is rampant. Venture funds cannot predict time to liquidity, and thus cannot plan for orderly capital formation. "

4. Low investment activity by VCs -- 11%

"Very few folks are investing -- at least not investing in new deals. Getting a deal done at whatever valuation is a major accomplishment right now"

"Most VCs are not looking at new deals even when they say they are."

5. Public stock market down, low IPO activity -- 10%

"General market tanking which is scaring everyone off..."

"Huge market change: public capital markets tanked."

"Increased uncertainty about the future of the IPO market, particularly for technology companies."

"It has become worse because the public markets have continued to underperform which impacts the private markets, particularly from a valuation perspective."

6. More stringent due diligence -- 5%

6. Valuations have dropped -- 5%

6. September 11 event -- 5%

"It was worse 6 months ago, an all time low, as venture firms either focused on current companies and/or were afraid to invest in new companies. My sense is that it began to improve in Q3 2001... but with the 9/11 tragedy VCs are back in their holes."

"Insecurity in the U.S. and global economies..."

7. Other -- 4%

1. There is VC money available and it has to be invested somewhere.

2. Entrepreneurs are more realistic about their valuations, there exists an opportunity for investors to invest in better companies and lower valuations.

Have valuations of start-up companies become more realistic in the past 12 months? Please rank from 1 to 5, 1 being much less realistic, 5 being much more realistic.

An overwhelming 84% of the VCs thought that start-up companies were being more realistic in their valuations with an average rating of 4.3. 45% thought that valuations were much more realistic than a year ago. Only 8% of the respondents rated valuations as less realistic.

A few VCs weren't sure this was a good thing.

Has the quality of the companies looking for capital improved over the last 12 months. In other words have the weaker business models and less capable management teams left the marketplace? Please rank from 1 to 5, 1 being the quality has substantially deteriorated, 5 being the quality has greatly improved.

77% of the venture capitalists said the quality of companies has improved over the last 12 months, the average rating being 4.0. Only 2% said that the quality had deteriorated, and 21% said the quality had stayed about the same.

Note that most VCs said the quality had improved (4) but not greatly improved (5). Venture Capitalists are forever searching for higher quality deals, it is their ongoing challenge.

Compared to 12 months ago, has the number of companies that contact you for funding increased or decreased? Please rank from 1 to 5, 1 being substantially decreased, 5 being greatly increased.

The activity level of entrepreneurs looking for venture capital has decreased a bit from the previous 12 months with an average rating of 2.8. A few VCs, 7%, said that the activity level had greatly increased and several, 9% said it had substantially decreased.

Do you believe the level of venture capital invested in early stage companies will increase or decrease in the next 12 months? Please rank from 1 to 5, 1 being substantially decrease, 5 being greatly increased.

55% of venture capitalists believe that the level of investing in early stage companies will decrease, while 11% believe it will remain about the same, and 34% think it will increase over the next 12 months. The average score was 2.8.

The most common reason given by the pessimistic VCs was that 'venture capitalists will still be focused on their current portfolio', 28%, as compared to 18% who said this was the most common reason for the current unfavorable environment. 'Risk' is cited at 16% for the future but not mentioned at all for the current environment. And 'no exit strategy' falls from 13% citing it as a current factor to 9% believing it will impact the future.

1. VCs will be focusing on their current portfolio of companies and won't have the time or resources to investigate new companies -- 28%

"VCs are holding their capital for existing portfolio company reserves, caring for their own young, not starting new babies as much."

2. Early stage companies are too risky/VCs are now more averse to risk -- 16%

"Few funds want to do early stage, most VCs are willing to sacrifice upside for reduced risk of loss."

"Investors are interested in companies approaching breakeven where no more capital will be required."

"No reward or premium for early stage risk granted by follow on markets. It's cheaper to buy than build right now."

3. Economy won't improve -- 12%

"In addition to the technology sector decline, the economic recession will push private equity investing deeper into a conservative model because existing portfolio companies will continue to struggle."

"Continued economic slump will prevent investors from investing."

3. Entrepreneurs aren't starting companies or have been scared off of looking for capital -- 12%

"Entrepreneurs are discouraged regarding funding prospects."

"Fewer entrepreneurs will try to raise money as fewer succeed in raising it."

"Fewer entrepreneurs are taking the plunge to form new companies."

4. No exit strategy -- 9%
5. Uncertainty -- 7%

"Everyone is playing the 'wait and see' game."

5. Less VC activity -- 7%

"The number of VC firms capable of doing real early stage investing, as opposed to stupid Internet early stage investing, has gone down, the money having been sucked up by the large firms."

6. Various other reasons -- 9%

For 34% of the venture capitalists who see the future improving, the most common reason given was that there is a tremendous amount of capital that has been raised and it has to be invested somewhere. As their current portfolio demands less and less of their time, they will be ready and able to invest. Start-up companies may get more attention, as the amount of the investment is smaller and the time to exit is greater so it gives the public markets more time to rally. And as one VC said "There is absolutely no investing being done today. Therefore it must get better."

1. There is a lot of VC money available and it has to be invested -- 37%

"There is more money to be put to work, it has to go somewhere."

"VC investing provides the greatest returns over the long run."

"VCs have money that they are being paid to put to work, and a fair amount of money by historical measures. Much of that un-invested capital is not reserved for follow-on and must be deployed in new deals."

"There are still billions of dollars of VC funds out there. I think the next 12 months will be a very exciting time."

"Investors are scared, but at the same time sitting on a lot of cash."

2. VC's have taken care of their own problems and will be ready to start investing --20%

"Most firms have wound-down most of their troubled companies, and will have more time to spend on new deals."

"VCs have triaged their portfolios and are looking for new investments."

"Problem companies will disappear and money will be put to work. The IPO market may start to come back in 12 months."

"We are at a low point in early stage investing; as existing companies wash out of portfolios, VCs will begin investing in early stage companies again. I believe it will take a good portion of the next 12 months for this to start happening however.

3. Economy will improve -- 15%

"I anticipate that the public markets will improve in the next 12 months and that IT spending will increase as well."

"Eventually the economy will right itself, capital markets will strengthen. VCs who have un-invested cash will feel more confident about making new bets and money will begin to flow back into start-ups."

4. Early stage investments use less funding, and have more time to exit stage than later stage companies -- 11%

"There's a lot of money in the system and no later stage opportunities until the public market returns."

"Many VC firms have re-discovered early stage investing due to the lack of a robust public market for exits."

"Less dollars and longer horizons to determine whether a company will succeed or not."

5. So low now it has to go up -- 6%

"There is absolutely no investing being done today, Therefore it must get better."

6. Various other reasons -- 11%

87% of the Venture Capitalists took the time to answer this question, sometimes with just a word or two, often with a paragraph of advice.

The most common advice was 'do without venture capital funds' and 'have a strong business model/plan/proof of concept.' In second place but not far behind, 'have a strong management team' followed by 'stretching the cash the company does have as far as possible.'

Below in order is the most often given advice:

1. Do without VC funding, bootstrap, or use friends and family money - 17%

1. Have a strong business model/business plan/ proof of concept --17%

2. Get a strong management team. -- 15%

3. Stretch cash, minimize amount of cash needed, get to positive cash flow -- 13%

1. Be realistic, persistent, and patience -- 10%
2. Have a truly revolutionary value, service, product, or technology -- 9%
3. Screen the venture capital firms to find a good fit -- 7%
4. Build customer base -- 5%
5. Various other reasons -- 7%

This may be faint good news but it does seem venture capitalists have a somewhat more positive outlook for the future. They don't foresee the environment as continuing to deteriorate at the present rate. The doom and gloom may be lifting albeit slowly.

VCs' response Previous 12 months Next 12 months

Average rating 1.9 2.8

(1 being much worse, 5 being much improved)

% worse or much worse 81% 55%

% stay the same 11% 11%

% improve 8% 34%

Less VCs view the next 12 months as worse or much worse than now and more VCs, 25 percentage points, see the future as improving.

The most common reasons given for the unfavorable environment for both the previous 12 months and the next 12 months are relatively the same. VCs are focused, and will be focused, on their current portfolio companies, the economy won't rally much and exit strategies will still be lacking.

It is curious one of the reasons given by 12% of the VCs who are pessimistic concerning the next 12 months, is that entrepreneurs aren't starting companies or just aren't looking for capital. That isn't supported by their response that the number of companies looking for capital has only marginally decreased.

Good news can be found in that the number of opportunities for future investment has only marginally declined but the quality of the companies has improved and the valuations have become more realistic. This, however may be a double edged sword. This return to more realistic valuations may be one of the reasons why VCs are having such problems with their current portfolio companies. Getting additional investment from other VCs or investing their own additional funds in their current portfolio companies forces the company to take a lower valuation than the previous money invested. New investments can be had at a much better valuation than their current companies.

The more the early-stage company is able to accomplish on its own, the more attractive it is to venture capitalists, who now put a premium on the existence of real, live customers rather than vague notions about the customers being 'out there.'

During times when capital is less plentiful, entrepreneurs have to be prepared to go it alone until more investors jump back into funding early-stage deals.

Finding capital for a start-up company has always been a difficult task, and many entrepreneurs have found it especially hard in 2001. But perseverance and taking the time to really understand what investors look for in a company are two ways of improving the chances of obtaining funding.

Investors in each of our annual surveys have stressed the importance of the management team. This year was no exception.

Capital is being 'rationed" out in smaller increments, and quick exit strategies are no longer the norm. Entrepreneurs have to build their companies as though they are in a marathon race.

Capital is now a more scare commodity than it was in 1999 and early 2000. The capital markets are rewarding entrepreneurs who are good stewards of the funding they receive.

As usual, venture capitalists were not in agreement about the outlook for early-stage funding. First, the gloomier VCs: