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Published in Print: August 8, 2001, as Seed Money Drying Up For Education-Related Businesses

Seed Money Drying Up For Education-Related Businesses

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Just over a year ago, anyone armed with an idea for improving education and a business plan could get a lot of money from venture capitalists, or so it seemed in the supercharged economy.

Now, that well has all but dried up. Venture investments in education businesses have declined steadily since a peak of just over $1 billion for the first quarter of 2000. In the second quarter of this year, the figure had fallen to $247 million, with none of that going to businesses focused on K-12 education, according to Eduventures.com.

"What we saw last year was a record amount of venture capital going into education," said Thomas S. Evans, a director and senior analyst with the Boston-based research firm, whose figures are widely respected in the industry. "But if you dug behind the headlines, there was a steady decline throughout the year."

It doesn't require a master's in business administration to understand the basic reasons behind the drop. As the economy has slowed, venture firms have been burned by some investments that went bust and have turned more cautious, especially about initial-stage funding of brand-new companies.

Moreover, venture firms made a lot of investments in Internet education businesses that, like Web-based businesses in other fields, have struggled to bring in any money, let alone profits.

And the downturn is by no means limited to the education arena. According to a report released last week by the National Venture Capital Association, the $10.6 billion in venture funding nationwide in the three months ending June 30 was 12 percent less than in the first quarter of this year, and 60 percent below comparable year-ago figures.

"Across the board in this country, it's not a great time to be a couple of smart kids in a garage with a business plan," said Jeffrey T. Leeds, a principal with Leeds Weld & Co., a New York City venture capital firm that focuses on education and training.

$2.9 Billion Last Year

Venture capitalists invest in early stage companies that show promise of leading to big returns. Unlike banks, venture capital firms take equity positions in the company and sometimes help run them. Venture firms look to relinquish their stake, at a profit, when a young company goes public in the stock market or is acquired by another company.

In the past two years, as the for-profit education industry has grown significantly, venture capitalists have been major investors, for example, in companies that manage charter schools, offer admissions-test preparation, and provide lessons and services online.

According to Eduventures.com, venture capitalists invested a record $2.9 billion in education companies last year, a 15 percent increase over 1999. Those figures cover not just businesses aimed at the K-12 market, but also postsecondary and corporate-training ventures.

Companies involved in K-12 received $723 million out of the total invested in education businesses last year, about 25 percent. But that figure is in for a sharp drop this year, with just $134 million invested in K-12 ventures in the first three months, and none in the second quarter, Eduventures reports.

Mr. Evans said the first-quarter figures were even inflated by some large, late-stage investments in established companies, such as a $43 million round of venture funding received by Bigchalk.com, an education Web site; and a $25 million round received by Princeton Review Inc., the test-preparation concern that went public on the NASDAQ stock market in June.

What does the drop-off in venture capital mean? For entrepreneurs who were late to the party but still believe they have a business plan worthy of investment, it will mean tough going in getting first-stage funding.

"We still get plenty of people walking in with ideas," said Todd V. Kern, a vice president of KnowledgeQuest Ventures, a New York City consulting firm that helps put education entrepreneurs together with investors. "And we just can't do it. The market is not there for first-stage funding. It's pretty bleak right now."

The lack of venture capital also leads to more merger and acquisition activity, analysts say. Companies that are up and running but can't get additional rounds of capital may be targets for acquisition.

In the school management world, such consolidation has begun: Edison Schools Inc. has acquired LearnNow, while Mosaica Education Inc. has bought Advantage Schools Inc. Both deals were announced in June.

"All the private companies we follow are under pressure to get to profitability or else sell to other companies," Mr. Evans of Eduventures said.

More Discipline

Despite the poor climate for luring investors, a meeting of education entrepreneurs late last month showed there is still plenty of interest in finding money for growth.

Most of the participants in the Association of Educators in Private Practice's Edventures July 26-28 conference in Los Angeles were small entrepreneurs who run their own tutoring centers or consulting firms.

Christopher L. Schwilk, who runs Specialized Learning Services, a Hummelstown, Pa., firm that provides sign-language interpreters and other specialists to school districts, attended a session about financing because his company is growing fast.

"I don't really even understand how venture capitalists work," he said as session leaders explained the tough capital market.

"There are transactions getting done, but they are few and far between," G. William Bavin, the managing director of Education Capital Markets Inc., a small investment firm focused on the education industry, said at the session. Keith J. Collar, the vice president of the Education Entrepreneurs Fund, the finance affiliate of Arlington, Va.-based New American Schools, said some good is coming out of the tight investment market.

"There is much more discipline in the market," he said. "And companies are realizing how little money they can get by on."

Funding for this story was provided in part by the Ford Foundation, which helps underwrite coverage of the changing definition of public schooling.

Vol. 20, Issue 43, Page 5

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