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A VC Take on the Market Crash: Short-Term Bear, Long-Term Bull


I don’t need to repeat the facts behind last week’s financial turbulence - from Lehman Brothers to Merrill Lynch to AIG and beyond. To paraphrase Jon Stewart, it’s a good thing the audience can’t see me cry during the commercial breaks. Beyond the obvious coverage in the Wall Street Journal, Business Week, The Economist and the Financial Times, a few of the sites I’ve found insightful are Seeking Alpha and the Prudent Bear.

Watching the carnage on Wall Street has been a spectator sport for most of us in the VC and start-up community. The rough going our investment banking cousins are experiencing has caused us to put down our popcorn and soft drinks and ask ourselves: how am I impacted? What will all this mean to the entrepreneurial economy?

In the dozens of meetings and conversations I've had with entrepreneurs and VCs this last week, it is clear that everyone is shell-shocked at the macro level, but surprisingly sanguine on the micro level. "Our traffic numbers keep going up and up," pointed out one B2C CEO, shaking his head in disbelief. "Our portfolio is basically not affected," claimed one VC with a tinge of hubris.

Yet everyone is clearly affected, it's just a matter of degree. Henry McCance, one of history's great venture capitalists and chairman of Greylock, was quoted by my partners (three of whom are ex-Greylock) as saying in the midst of the 1998 Long Term Capital crash (which some say was worse than the 1987 market crash), "We know our portfolio is down 30%, we just don't know where."

But it's better to be down 30% than 300%. In truth, most early-stage companies are not that affected by the stock market gyrations or even a general recession. Yes, some consumer-based "If you build it, they will come" businesses will be more susceptible to the inevitable pullback in advertising spend. But most venture-backed start-ups are technology-driven with deep Intellectual Property (IP). If the technology works, value is created. With only a few customer proof points, a few million of revenue can be generated from scratch and even more value can be created. The holding period for early-stage start-ups is typically 6-8 years, and so an episodic recession shouldn't materially affect long-term value creation, so long as follow-on financing is available. One VC observed that his partnership had done an analysis and realized that, "we have 20 companies in our portfolio seeking follow-on financing this year. They'll nearly all get done, but none of them will be meaningfully up rounds. Instead, there will be many flat and down rounds ahead."

But the VC and entrepreneurial community went through a far rougher period only a few years ago and most firms are run by executives who remember those times and remember the prudent actions required: cut costs, but don't cut to the bone; raise more capital than your plans suggest you need to cover the dry period; in general, increase fund reserves and assume longer holding periods; with employees and investors, set expectations for patience and long-term business building rather than quick hits and quick flips.

Further, I would observe that many of the macro-trends that the entrepreneurial economy is based on remain very positive. For example, I would argue that the following trends are inevitable:

• The $600 billion advertising industry will shift to online (particularly search) and mobile -- an area that is still growing north of 20% per year.

• Advances in nanotechnology and materials science will yield valuable medical technologies and devices - with health care spending still 18% of GDP, this is a big sector of the economy ripe for innovation and value creation.

• Advances in energy technology will yield profitable new approaches in solar, wind, LEDs, batteries, and numerous other renewables - revolutionizing this massive industry (see Tom Friedman's inspiring NYTimes magzine: "The Power of Green").

• Globalization (reported thoughtfully in a special report in this week's Economist) continues to accelerate, making it easier for young companies to attract capital and deploy resources in the most efficient locations, irrespective of geographical barriers.

At the same time that these macro-trends are bubbling along, the fundamentals of the start-up ecosystem remain strong -- seasoned (and novice!) entrepreneurs are enthusiastically tackling these issues. Venture capital funding remains plentiful - almost everyone in the industry will tell you there is still too much money chasing too few ideas (good for entrepreneurs, but more challenging for individual fund returns!). The ecosystem has modest dependency on the debt markets, inflation or commodity prices.

For all these reasons, although I am a short-term bear (yes, it will continue to be an ugly year or two for the global macro economy), I remain a long-term bull when it comes to the entrepreneurial economy and the potential for start-ups to impact the world and create value.


Toyota's Hydrogen Man
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