Start-Up Your Engines!

Venture capitalists are the NASCAR racers of entrepreneurship, injecting fuel private investment dollars into new companies that are exciting but may come apart at high speeds. It's a high-risk profession. They have driven important new technologies to market, creating new jobs and new industries. Apple Computer, eBay, biotechnology pioneer Genentech, Federal Express and, most notable of late, Google, all grew out of daring private investments. In the 1990s "suddenly venture capitalists became rock stars," says Mark Heesen, president of the National Venture Capital Association. Since 1970 venture capitalists (VCs) have pumped $339 billion into start-ups; these companies have created 10.1 million jobs and collected $1.8 trillion in sales. But stars tend to flame out as quickly as they ignite. By the time the Internet-bubble burst, "vulture capitalists" were tainted as part of the lunatic feedback loop that sent valuations of newly public companies into the stratosphere. After three years of retrenchment, the community of some 900 U.S. investment firms is eager to lend a hand to what it hopes will be the next generation of giants.

Heesen and four other veterans visited TIME last month for a talk that served as an epilogue to the Internet era and a prologue to innovation to come. Brenda Gavin, managing partner of Quaker BioVentures; John Preston, associate director of the M.I.T. Entrepreneurship Center; Gary Rieschel, managing partner of Mobius Venture Capital; and Susan Woodward, founder of Sand Hill Econometrics, joined Heesen on our Board of Technologists.

TIME: What lessons did you learn from the Internet bubble?

GAVIN: The No. 1 lesson is we have to make sure we have a market for our products. Who cared about a website for a dry cleaner? I don't think the health-care area was hit hard by the bubble. We have waveswe don't have bubblesin health care. It's very capital intensive, which works against that trend.

HEESEN: The last thing we want is irrational exuberance going back into this market. We invested nearly $106 billion in the year 2000--a total aberration historically. A lot of press reports use that inflated figure as a benchmark, which in our opinion is very wrong. We wouldn't mind seeing that year erased.

PRESTON: I would say the biggest single problem we have is a tendency to follow what others are doing. A lot of me-too venture funds are nearing the end of their investment cycle, so the venture capitalists are returning to their roots. But because new technologies aren't ripe yet or there's a lack of people to make companies out of them, venture investors are not putting their money to work as aggressively as they should. They have an "overhang" to the tune of $50 billion. Others are still overpaying for some investments.

RIESCHEL: One example from last year is social networking. That was ridiculous from a moneymaking perspective.

TIME: Like Friendster?

RIESCHEL: We looked at five sites and passed on everything. In '99 everyone got in trouble when maybe 17 companies were all trying to sell pet food online. At Mobius, now if we identify more than four venture-backed start-ups in a sector, we won't bite. There are at least 14 social-networking sites.

PRESTON: I look at deals, and I try to look at what I call the hype-to-substance ratio. If the hype is up here, and substance is down here, I avoid getting involved.

WOODWARD: Start-ups are bouncing back. Our index of venture firms is up about 40% from its trough in late 2000.