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(Editor’s note: Don Rainey is a general partner at Grotech Ventures and author of the  “VC in DC” blog. He submitted this column to VentureBeat.)

Throughout the financial crisis of 2008-09, most venture capitalists wisely advised startups to hunker down. The best bet, they said, was to lower expenses and, above all else, avoid fundraising in 2009, since all eyes were on 2010 as the proverbial light at the end of the tunnel. 

The advice, as it turns out, was somewhat short-sighted.

We are now 18 months past the height of the financial crisis. Back then, it didn’t require a doomsday-oriented PowerPoint presentation to know that difficult times lay ahead. The same, frustratingly, can be said today. This is a different capital environment, but it’s not necessarily any better. It’s just different – and it may be worse.

Because so many companies avoided fundraising last year, there is currently a glut of companies that likely need cash. Accordingly, the competition is fierce, and it includes many companies that didn’t grow much (if at all) in 2009. Many companies seeking funding in 2010 are (or soon will be) out of money, and as a result they’re in poor negotiating positions. Even good companies are fighting for one of history’s toughest investment pools.

For all the back and forth, thrust and parry, and plain old bitching by, between and about entrepreneurs and their investors, we all are sailing in the same boat. Most investors were once entrepreneurs and many entrepreneurs will become investors.  And, together, we are facing a great shakeout at a time when the country needs the innovation and the job growth that startups provide to the economy. It demands that we, as VCs, exercise great caution in identifying companies to back or continue backing in 2010.

In this environment, there is no cash for clunkers unless, of course, we’re talking about the government. The downward pressures of a year like 2009 push good companies (meaning ones that would have done well or reasonably well in a typical year) and the bad ones (meaning ones that wouldn’t have done well even without the downward environmental variable) into the same pool.

You could argue they’re always in the same pool and that only the great companies stand out. That’s true. It’s just truer right now. And distinguishing the two is the difficult task faced by VCs.

If your startup needs cash in 2010, present the facts to potential investors without apology and don’t gloss over the need. You may not get the deal you had hoped for, but you will keep your dream alive.

Look for investors that have complementary portfolio companies, which heighten the chances of an exit via merger or acquisition. And if you’ve previously secured initial funding, you’ll always do better staying with your current investors, since they have already supported the vision.

VCs, in the meantime, need to look forward, not back. Companies need to be judged, above all else, on their potential to succeed in the future. The past is important, but as all good investors know, past performance does not guarantee future results.  The companies that are most likely to succeed are the ones that did the most with the least in 2009. They typically have a nimble business model, a clear vision for success and an obvious market need – and those qualities should be at the fore of any 2010 investment discussion.

Photo by shawn.miller via Flickr


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