Venture Capital acts like grease on innovation's wheels. Investments help fund companies to improve on existing conceptualizations or change technical paradigms. However, given 2008's fourth quarter performance, which Sam Stovall, Chief Investment Strategist at Standard and Poor's Equity Research, said prosaically "was pretty bad," one has to imagine that investments in new innovation might take a back seat until the markets improve.

To learn more about how the markets are affecting Venture Capitalists' behavior and therefore, the companies that depend on them, I spoke with David Hornik from August Capital and the author of VentureBlog and VentureCast. David's biography at August Capital describes much of his background, including that he "invest broadly in information technology companies, with a focus on enterprise application and infrastructure software, as well as consumer facing software and services."

In his legal practice, David represented high tech startups in all aspects of their formation, financing, and operations, including the likes of Yahoo!, Evite (Ticketmaster) and Ofoto (Kodak). His current board affiliations include DoneRight, Nomis, PayCycle, Six Apart, Splunk, VideoEgg and he has investments in eBates, Jaxtr, LiveOps, Technorati.

He holds an AB in Computer Music from Stanford University, an M.Phil in Criminology from Cambridge University and a JD from Harvard Law School.

Erik Levy: As a starting point, can you provide a little background on yourself?

David Hornik: Sure. I grew up the son of a computer scientist and loved technology but ended up getting a degree in computer music, which didn't actually qualify me to do anything. As a result, I went to law school and practiced law for half a dozen years. I started out as a litigator but found my way back to the Bay Area around 1997 and started to work representing startups. I found startups completely addictive and tried my best to engage in my clients businesses, not just the law.

In one instance, I was fired for not focusing enough on the law. In another instance, I got to know the venture investors well and about 9 years ago was asked to join August Capital, where I have been since that time.

Erik Levy: It states in your biography on Augustcap.com that you have "a focus on enterprise application and infrastructure software, as well as consumer facing software and services." Why those areas?

David Hornik: I love software. It is amazing to me how much one can accomplish with a relatively small number of lines of code. But I like to think of software really broadly. I have backed great entrepreneurs who are using software to solve a pretty broad set of problems -- online payroll (PayCycle), blogging (SixApart), distributed call center (LiveOps), price optimization for banks (Nomis), search engine for your data center (Splunk), et cetera. In each instance I was taken by the energy of the team and their approach to solving a problem that they had identified in a really smart way. So, I like to keep an open mind and look broadly at enabling software technology.

Erik Levy: I had mentioned to you that I was curious how, if at all, the financial de-leveraging and associated fallout in the markets has affected your investments or the behavior of the companies you look at or already invest in. Can you speak to that?

David Hornik: The biggest impact of the current financing environment is really on those companies started half a dozen years ago. There are some really great companies out there that are grossing more than a hundred million dollars and making money. Those companies should be public companies and in a normal environment, they would be. Unfortunately, in the current environment, there is no public market. So they need to continue operating and growing and hope for liquidity some time in the future. That's no problem if the company is cash flow positive. It is a much bigger problem if the business is losing money. It is a VERY tough time to raise money right now.

Erik Levy: It that because it is difficult to get additional funding into the venture funds or some other factor?

David Hornik: Why is it hard to raise money now? You have to look at it as a pipeline. If the end of the pipeline is the IPO market giving successful companies liquidity, imagine what happens when the IPO exits close up. It constricts the rest of the market. Yes, there are still exits in the form of acquisitions. But without the alternative of going public, companies can't get the valuations that are competitive from an acquisition standpoint. So acquisitions are done at lower prices. If acquisitions are done at lower prices, financing at later stages have to be done at lower prices. If the financing at later stages are done at lower prices, financing at early stages are done at lower prices, et cetera. The result is that the entire capital market for startups is constricted -- constipated may be an apt analogy.

David Hornik: With respect to the early stage startups I am funding today, the environment doesn't have a huge impact on how I think about investing. It is always hard to build a startup. There are a million things that could go wrong. It is tough to convince people to leave secure jobs to work in a startup, it is tough to raise money, et cetera. All those things are tougher in this environment. But, as a result, the folks who start companies in these challenging economic times are really committed entrepreneurs. So, that counteracts some of the challenges of the environment. The partners at August Capital have made some really successful investments in past economic downturns (for example, my partner Dave Marquardt, invested in Microsoft in a challenging economic environment). So it is largely business as usual for me when it comes to looking at new, exciting companies.

Erik Levy: The difficulty you mentioned is from an entrepreneur point of view?

David Hornik: Yes, the hardship is from the standpoint of the entrepreneur.

Erik Levy: Obviously, the markets have gone through painful times before, do you believe this one is different? That is, if I try to take your analogy in a polite way, should entrepreneurs wait for things to become less constricted?

David Hornik: And they will again. The markets are cyclical. In the late 90's it was easier to get companies public than it should have been. In 2002 it was harder than it should have been. I think that we are in a "harder than it should be" part of the cycle. I suppose what is different right now is that all of the financial institutions are under huge pressure. The entire infrastructure for the public markets has largely been dismantled and will take a while to rebuild. So, it is a bit of a chicken and egg problem.

First, we need to get confidence back in the capital markets. Then, we need financial institutions rebuilt to support the capital markets. Then, we need the IPO window to open again. And then we can get some companies public again. I am certain that will happen. The only question is the time frame. It seems unlikely in 2009. But will the markets regain some momentum in 2010? 2011? We will have to wait and see.

David Hornik: Should entrepreneurs wait until the market is less constricted? Definitely not. By then it will be too late. Timing is everything in the startup world. But it is really hard to time markets. So the best thing you can do is build great businesses when you have the great idea. Eventually there will be a market that allows for liquidity. In the mean time, as a general matter, great teams building great companies can figure out how to get funded and build big businesses no matter what the market. And those companies that have been built during these challenging times will be at the front of the line when the public markets open back up.

Erik Levy: Where does that leave your investment strategy - you mentioned that the market doesn't have a huge impact on how you think about investing but at the same time, there is the pipeline effect in that companies need to continue to get investments until they are profitable. It seems like there is a bit of faith in terms of assuming even after your investments, that others will continue the torch.

David Hornik: Like I said, great companies have a way of finding new believers. The funnel definitely gets more constricted but great companies can usually find people who are willing to continue funding them. It is also the case that in these sorts of economic times, companies often look to their existing investors to continue funding them. If you believe that a company has the capacity to grow into something big and interesting, you will continue to fund it over the long haul. I suspect we'll be seeing a lot more insider-led financing in 2009 than we did in 2008. But we will also be seeing a lot more companies that simply run out of money. That's just part of the cycle. All I can do is hope that it isn't my companies and give them as much support as I can.

Erik Levy: You have a blog at ventureblog.com - how did that come about?

David Hornik: I started VentureBlog back in 2002. At the time there were no blogs about the venture capital industry. The conventional wisdom was that the venture business was a black box and should stay that way. I didn't frankly see it that way. I thought that there were lots of things that I could write about that would be helpful to entrepreneurs (what are VCs looking for in a pitch, what do they look for in term sheets, what are interesting technology areas, et cetera).

Erik Levy: Do you find it acts as a good marketing tool?

David Hornik: I suppose it is a marketing tool. My view is that the better an entrepreneur knows who you are and what you are looking for, the better they can determine if they and their business are a good fit for you. When VCs invest in your company, it is a little bit like a marriage. You are stuck with each other for a long time. So you shouldn't just jump into it on either side. Both VCs and entrepreneurs should do a lot of diligence on each other. I think that VentureBlog has been a good way for entrepreneurs to get to know me.