07 Nov A venture-capital take on the financial meltdown
What’s someone – say an early-stage entrepreneur in the market for venture capital funding – to make of the current turmoil in the financial markets? A fair amount, I think, most of it not very good, but some of it, at least in the long run (assuming, against the advice of Keynes, that we are alive in the long run), not so bad. You know what they say about clouds and silver linings.
First, the clouds. The bad news is that current events will probably make it tougher to raise early-stage venture capital over the next couple – hopefully not few – years. Many of the financial players hit hardest by the credit crisis, including some who have gone under, are (or have been) substantial investors in venture capital. Not only are many of these institutions pulling back from new venture investments, a non trivial group of them is likely to default on capital calls by their existing venture fund commitments.
Less money in the system can’t, and won’t, be good for entrepreneurs seeking their first round of venture capital, and will even threaten some existing portfolio companies that will find their current investors increasingly protective of their shrinking pools of dry powder.
Bad news bear market
The above by itself probably would not have a terribly significant impact on early-stage entrepreneurs. Alas, there is more, and worse, news. Basically, with a significant decline in asset values, many of the major players funding the venture capital industry are likely to cut back, whether or not their survival is at stake. Not only is there the general “flight to quality” (which, in plain English translates as a shift away from high risk/high reward investments like venture capital), but in addition many such investors target their exposure to venture capital at a percentage of their total investment portfolio. When portfolio values fall, say, 20 percent, so to will their commitments to venture capital funds.
Finally, all of the above is taking place – perhaps not coincidentally – when more traditional indicators, most specifically the IPO and M&A exit windows – are as closed as they have been in a long time. That is still another reason for fund managers to focus on keeping existing portfolio companies alive, rather than funding new start-ups.
In sum, it’s the proverbial perfect storm for the venture capital industry.
But what about that silver lining that I mentioned? Well, it may not provide a lot of comfort now, but down the road the Wall Street debacle might have some unexpected pluses for the venture capital industry and the entrepreneurs it finances. The argument runs something like this:
Since the mid 1980s (remember Michael Milken and the Junk Bond revolution that fueled the market for corporate control) until the recent unpleasantness (as some of my friends in the South still refer to the Civil War, or, as they call it, the War Between the States), an increasing portion of the best and brightest the business schools have had to offer have gone into the big ticket financial industry, where great fortunes could be “earned” by cleverly inventing and marketing increasingly complex securities to increasingly clueless customers.
What will happen to these gold-diggers now? Well, some of them, maybe/hopefully a lot of them, will turn their still clever and active minds to more productive, value-added rather than value obscuring endeavors – including, perhaps, venture capital and the enterprises that it funds. As I said, it’s not much of a silver lining; still, at least it’s ours.
Cheerio. I guess.
Recent column by Paul A. Jones
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