Time to Get Worried About the Looming Venture-Finance Crunch

Every start-up needs money at the outset. Hewlett-Packard (HPQ) had $538 in working capital. Apple (AAPL) got its early funding, a reputed $250,000, from a former Intel (INTC) engineer who struck it rich on his stock when the chip maker went public.

Unfortunately for tech entrepreneurs, seed money has become harder to get and the outlook is worse. A witching hour triple threat endangers the ability of start-ups to raise money. A combination of fundamental shifts on Wall Street, regulatory modifications from Congress, and changing habits of venture capitalists will shake how young companies seek funding to establish themselves and grow.

Anyone watching U.S. industry knows that initial public offerings have been weak. In 2009, the number of IPOs was the lowest since 1999, so long as you don't count 2008, which was even more of a bomb. The problem is a fundamental change in how Wall Street does business. As billionaire investor Mark Cuban notes, Wall Street is largely out of the business of raising capital for companies:

Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks. And those macro issues impact automated trading decisions, which impact any and every stock that is part of any and every index or ETF. Combine that with the leverage of derivatives tracking companies, indexes and other packages or the leveraged ETFs, and individual stocks become pawns in a much bigger game than I feel increasingly less comfortable playing. It is a game fraught with ever increasing risk.

Suddenly, there is no predictability in the markets. Too many people want to jump on the sudden wealth bandwagon and get the big hit. That means not investing money in companies, but gambling it on companies. The difference in those two states of mind is enormous. A young business that seeks capital for growth needs more than strong and intelligent strategy, operations, and possibilities. It must have some big play in a particular market that seems to offer an enormous win.

Next up, the financial reform bill that Congress is considering. Some provisions will have significant impact on start-ups. For example, there are currently provisions in the law that allow small companies to raise money and yet avoid much of the regulatory overhead by getting funds from so-called accredited investors. Aside from the usual institutional investor crew, an accredited investor can also be a person or couple with a net worth over $1 million; a person with an income exceeding $200,000 or a couple with joint income over $300,000; or a person with a trust whose assets are greater than $5 million. Angel investors fall into this category.

According to the current version of the Senate bill, those bottom-line requirements will go up, adjusted for inflation. As Rhonda Abrams in USA Today noted, investors will now need $1.3 million more in net worth or and additional $200,000. That means fewer people will qualify for accredited investor status, meaning that the number of angel investors drops.

Furthermore, the bill affects how companies can look for money accredited investors. State regulators will get more influence. Companies will need to file 120 days before collecting money. Investors might go elsewhere rather than raise money and filing after.

Finally, VC's are turning away from high tech to focus on more newer investment opportunities. According to a graph from the latest report by Pricewaterhouse Coopers and the National Venture Capital Association, VC activity has dropped off significantly over the last 8 years:

Less money, fewer opportunities, and more hurdles mean that getting start-up funding will be more difficult than ever before. Entrepreneurs will need to consider additional routes to money -- if they can find them.

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