Volatility scares venture capitalists

This year has been a half of two quarters, with the Techmark rising from 2,750 in January to 5,750 in March, before tumbling back...

This year has been a half of two quarters, with the Techmark rising from 2,750 in January to 5,750 in March, before tumbling back down again to below 3,000 in May.

Ian Mitchell

City Briefing

Fortunes have been won and lost, but the biggest problem with the volatility in the sector is likely to be its effect on the venture capital markets.

Before the rise in the Techmark index it was difficult for technology companies to get the funding to support their ideas and business plans. In some cases potential investors barely understood what they were looking at and it required a certain amount of bravery on their part to agree a deal.

That all changed when private equity investors saw the returns to be made by backing ventures that promised outstanding returns on flotation. There was a time when technology company floats were almost considered a failure if their share price didn't double on its debut.

While many companies producing excellent technologies caught the wave and received substantial investment funds to develop their offering and chase the market, so too did many dubious businesses that just happened to catch the wave at the right time. I'm thinking here of some of the more esoteric dotcoms.

Many start-ups attracted high-calibre individuals, including IT professionals, tempted by the lure of stock options that promised riches far beyond what most employees could ever expect to earn.

There was (and still is in the quality companies) a real entrepreneurial spirit surrounding many of these businesses. Venture capital trusts, wealthy individuals, technology incubators and traditional private equity investment firms competed to invest their money in what they considered to be the best prospects at ever increasing valuations. Even the Queen put £100,000 into a dotcom.

Following the drop in the Techmark, the contrast could not be more obvious. Instead of looking at this as an opportunity to invest in private companies at correspondingly lower valuations, many investors have decided to withhold further funds until the situation stabilises. In many cases there is little consideration given to the quality of the investment opportunity - the shutters have simply come down.

This has left many technology companies in a dangerous limbo situation. IPOs have been postponed or cancelled, leaving the companies concerned to hope that their market opportunity does not pass them by and that investors and staff do not become disillusioned by the uncertainty.

In the case of quoted companies whose cash burn is significant, it raises questions about whether they remain a viable proposition if they cannot secure further financing before they can generate cash internally.

Beneath the headlines about falling share indices there lies a great deal of anxiety and, not to overstate the case, question marks about whether the UK is capable of building and supporting a solid IT sector.

We need a period of stability to give investors the courage to begin believing and investing in technology again. If we get it, we will be able to look back on this period as a hiccup - if not, there could be a great deal more pain to come than just the demise of Boo.com.

Ian Mitchell is an IT analyst with stockbroker Beeson Gregory. His opinions should not be construed as investment advice.

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