Dateline: August 13th 2011, Saturday, after the tumultuous markets have closed…
There has been some chatter online this past week raising concerns about venture capitalists pulling back on their funding activities, in light of this week’s erratic activity on the stock market, and the withdrawal of several planned IPOs. I want to share several positions about this with you.
In case you were off the grid last week, here is a short re-cap posted Wednesday, August 10th. Thursday and Friday the stock market went down and up, and settled the week down.
Of the two (stock market chaos or lost IPOs), the change in IPO activity may be the most significant. Venture capitalists are excited by a predictable exit market, either strong M&A (mergers and acquisition) activity or several powerful IPOs coming in the near future. If they believe they must wait for these liquidity events, or cannot predict when these will be active, the VCs will become more conservative in their choices, and protect their portfolios.
From the Associated Press, again on Wednesday August 10th, about the cancelled IPOs:
“Tempest in a teapot” one of my clients remarked (although, as we have increased his personal consulting income to $400-$500K this year, he may not be concerned). I also wondered why the sudden stock market strangeness (I understand the IPO behavior) should appear now, when the world has had the information of its economic state for months and months. Yes, Europe’s troubles looked worse, and the S&Ps hissy fit has some news hype value, and somebody spat in France’s eye, but really — all this news is more of the same, if realists were confronting the underlying conditions for the past months and years (that is, that nothing in the core of the troubles has been fixed since 2008 – but more on that next week).
But, I digress.. back to the chatter and links.
So, some are saying that the economic uncertainty reflected by the stock market’s roller coaster behavior will drive venture capitalists, particularly those investing in early stage tech stocks, to stop investing. By “stop investing” they mean that the venture capitalists might retreat into the behavior we saw after the tech crash of 2000 (and the economic downturn following 9/11 in 2001) and the economic crash of the Great Recession in 2008.
I was there for each of these, and yes, there was a pattern in all that, and it could recur. It looked like this:
- Deals that were not completed at that time rarely were completed.
- VCs took, justifiably, defensive measures to ensure that their existing portfolio companies had enough capital to move forward on their growth cycle. The VCs allocated much of their existing Funds to those investments already secured. This left much less for “venturing” into new risks. And the VC’s return on investment (ROI) on their portfolios was threatened, and that ROI is the basis of the VCs being able to raise their next Fund and so to survive.
- VCs became more conservative in the risks they would take. On my various VC panels in the tech industry (Digital Hollywood, CES, and others), they admitted (this was 2008 and early 2009) they were “broadening their early stage searches” to include those startups that had revenue and market traction. This criteria became a standard, leaving seed and Series A capital more and more to angel investors and angel groups.
- Deal terms became more aggressive against the entrepreneur, to protect the VCs from potential downside.
- Years of limited capital drove entrepreneurs to bootstrap their companies (since there weren’t jobs for them anyway) and get their companies into a much safer stage once the capital began to flow again.
One entrepreneur has an optimistic outlook about building new businesses when “winter is coming.”
And here is a neat contrarian blog on the case for the “Fat Startup” from Ben Horowitz, co-founder/general partner of Andreessen Horowitz, from March of 2010, worth considering:
I am avoiding all political commentary here, and caring only about the robustness of the U.S. economy in the sectors where I can make a difference: with my clients, who are early stage tech and tech/media entrepreneurs (and I have been through 5 cycles of technology or economic downturns).
My concern is that the cycles of boom and bust are coming too close together.
- After the downturn of 2000/2001, the VCs didn’t get truly active again until 2004.
- The next bust was 2008, with investment beginning again in 2010, and more actively in 2011.
- Three to four years of an active investing cycle is not enough time for entrepreneurs to recover from these downturns, especially if the uptick in investing lasts only 3 years going further. This cycle stresses the VCs and their new Funds as well.
- VCs are handling portfolios with an exit cycle of 6-8 years from funding. Entrepreneurs may launch and get traction in 3 years after funding (which means 4-5 years after they begin the company), but they are rarely scaling until year 4 post-funding.
- Notice the age of the potential IPOs — up to 8-10 years to build value and find a good IPO window (perhaps now closed again).
In the larger picture, technology and media are the best and most widely received exports from the U.S., year after year. I know the world economic problems are larger and deeper than my little sectors. That said, my little sectors offer significant players in our economy and around the world. Apple? Google?
So, the chatter may be too dramatic and too soon. Or too dramatic and woefully late, given what we have known about the economy since 2008.
What to do? More on that next week, but for now–
- keep building your companies, your technologies, your breakthroughs. Who knows what will happen next week or next month?
- Consider alternative forms of funding — private funding for an idea re-conceived for this new economic reality; strategic funding from a win/win bigger company that needs what you have; licensing and strategic revenue and no equity or debt funding at all;
- Consider a different take on your product or service idea, or your target market sector, or your market timing, and create a company that builds wealth for you independent of the vagaries of the stock market and other people’s ideas about capital, risk and what is real. This is my favorite kind of company to build.
More next week on this, and ideas for avoiding the crisis of downturns.