How Does The Market Craziness Affect Venture Capitalists and Startups?

Lately, I’m being asked this question several times a day.  Sometimes its from nervous entrepreneurs looking for funding, sometimes it’s from our investors wanting to know what I’m seeing and yesterday, from my father who is evidently worried that things are so bad that I might have to move back home and into his attic.  (No worries Dad, I’m good).

Frankly, we haven’t seen any affect on our business (caveat: so far – see below).  Our investors are still making their capital calls and our insurance policies seem to still be worth something due to the government’s bailout of AIG. 

Furthermore, all our Foundry Group portfolio companies are too young to pay much attention to macro economics and are heads down building their businesses.  This isn’t to say that they are spending money as if it were 24 months ago, as each are certainly being as cash efficient as reasonable, but in general our expectations for our companies have been met or exceeded despite the meltdown.

We are still seeing interest from prospective co-investors in funding our deals and, for the moment, everything seems quite "normal" if one can ever use that word in early-stage investing. 

So what might happen if the meltdown continues "indefinitely?"  Well, since I keep getting asked, here are the doomsday predictions, although I believe we are far from that day.

1.  Angel investors will disappear.  We saw this in 2001-2003 whereas individuals, either nervous, or more cash strapped than before, exited the angel investing market.  My partner Brad likes to use the "flipping of the switch" analogy when describing this market.  Of all my predictions, this one is the most likely to happen.  This could have a material impact on startups who rely on angel funding to bridge the gap between company formation and venture investment:

2.  VCs could just stop investing.  We also saw this phenomenon after the dotcom bust and it never made that much sense to me, especially in the early-stage ecosystem, but it could happen.  Certainly the late-stage investors have slowed / stopped, but my opinion is that early-stage investors should continue to deploy capital at a roughly equivalent rate each year.   

3.  Investors in VC firms, short on cash, could default on their obligations.  This is less likely if your VC firm has institutional investors, but for VC firms with many high net worth investors (who may not longer be high net worth folks), this could happen if the liquidity crises and stock market crash continue.  In this case, suddenly VCs are either unable to invest in new companies or support their current ones. 

I think the key is for entrepreneurs to realize that fundraising will be either a little or a lot tougher for the foreseeable future.  Conserve your cash, if you have it. It’s not all doom and gloomStay steady and don’t freak out like Bill Murray did in Ghostbusters (great clip, if you haven’t seen the movie in a while).

  • excellent advice jayjay!

  • I hope that you are correct – sincerely, but if the past is any indication of the future, my bet is big slowdown in that part of the ecosystem.

  • Just to play Devil's advocate, Jason, I'm not entirely convinced that angels will go away. I think that such a phenomenon has much more to do with the portion of their overall investment outlay tied up in rather than the nature of the market. If anything, a downturn could be seen by savvy angels as a time to buy good solid ideas with long term futures. If they can preserve their burn and go positive before conditions change, so much the better.

    As much as I do believe that many investors will run scared, I believe even more strongly that a few months to a year of sub-par returns will renew their will. After all, chasing returns in a low-return environment arguably provided the catalyst for our current mess.

  • Remember, VCs don’t get all their money up front. They have commitments from their investors to give them money in the future, so the money isn’t lying around doing nothing, rather the money is still in the banks of the investors. There are not funds to “freeze” rather the question is whether or not they will just stop investing because of the current market and not call those funds from their investors. We’ll see, but if history is a guide, my guess is that fundings decrease.

  • It could well be, but the situation isn't the same as 2000-2001, we don't see many VCs with two or three-digit million amounts invested, and companies are much more efficient and can run on fumes for longer.

    My question would be – there are plenty of funds (VC) that are only part-invested, what happens to those funds? Does it make sense to have them laying around not providing any potential for returns? VCs will be much more careful about throwing a million bucks at a PowerPoint for the next social network, and will look for solid teams, products well into development, and a credible path to profitability – but I don't think it would make sense for them to just freeze the funds.

  • All great points Jason. I may add one silver lining that we have observed, especially for early stage companies (development / research stage). That is, development dollars go further today than they have in the past several years, both domestically and internationally. In short, a company should be able to get further on that recently completed A round than prior projections show. This puts well funded early stage companies in the driver seat and ultimately mutes the volatility observed in today's crazy markets.

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