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2 posts from January 2008

January 23, 2008

Who's Afraid of the Big Bad Recession?

With yesterday's 0.75% rate cut by the Federal Reserve, the press has been rightly focused on the ripple effects that the soft economy will have on the US and the world.  Amidst the high-level analytical fervor, the mainstream press has not probed on the implications to the venture capital/start-up economy, which fuels so much innovation, particularly here in Massachusetts.

There are two interesting competing forces at work.  First, venture capital investments are obviously negatively impacted by the down turn.  Start-ups that were funded during what will be seen as the "go go days" of 2005-2007 will struggle to maintain their growth and momentum through the economic head winds.  If VCs invested in these companies at inflated prices and, on the margin, over-capitalized these companies, their returns will suffer.

But on the flip side, looking prospectively at the VC asset class, one might argue that it is suddenly looking more appealing than ever, particularly on a relative basis (reminds me of the joke about the two "buddies" being chased by a bear realizing that they don't have to outrun the bear, just one another).  Over the last five years, our later stage private equity cousins benefited tremendously from cheap debt, a rising stock market and a robust IPO market.  Spectacular buyouts could be executed with modest capital at risk relative to the total deal size and then flipped for a nice profit 2-3 years later.

As a result, limited partners began to pour a greater share of their "alternative" asset class dollars in private equity and holding their venture capital exposure relatively costant.  But with a choppy stock market and evaporating IPO environment, suddenly those easy buyout returns don't look so easy any more, particularly given its dependency on the US banking system, which is the sector of the economy that appears hardest hit.

In contrast, the venture capital asset class is looking pretty good right now, with its 10 year window that in theory can skate through a few economic cycles and a sector exposure that's more dependent on IT budgets (which appear to be remain reasonably robust, with IDC forecasting 6% growth in worldwide IT spend to $1.3 trillion in 2008) and the shift of marketing dollars to digital environments such as the Web and mobile (which appears inexorable, with Internet advertising forecasted to grow to $24 billion in 2008, almost a doubling from $14 billion in 2006).  It is interesting to note that on the same day that the Fed announced its rate cut, the Dow Jones announced a modest increase in 2007 of VC dollars invested of $30 billion (8% above 2006 across the same number of deals) and a nice balance of fund flows with $32 billion raised.

The last economic cycle demonstrated an interesting lesson for VCs - start-ups that were created during the 2001-2003 downturn have proven to be terrific investments 5-6 years later.  Incubating small companies during economic downturns, forcing managers to be prudent with their capital and quietly positioning themselves for strong growth and leadership when the market turns, is an age old start-up playbook for success.

My advice to entrepreneurs - don't wallow in self-pity about the negative impact the economy will have on your 2008 performance.  Instead, this is a great time to hunker down, steal incremental market share and build a valuable company that will be poised to take advantage of the predictable upturn around the corner.

January 10, 2008

2008 Boston VC Blog Predictions

As I did in 2007 as well as 2006, I thought I'd throw out a few predictions for 2008.  So here we go, in no particular order...

1) No Recession. As Agent Maxwell Smart would say:  "missed it by that much".  I am short-term bearish about the US economy and, like many of you, have watched with great concern the emerging credit crunch, real estate asset bubble, US dollar devaluation, rising oil prices and inflationary pressures.  That said, I think the US economy will power its way through 2008 without slipping into a recession (which is technically defined as two quarters of negative GDP growth).  Yes, we'll see anemic growth and more stock market turmoil, but corporate profits and international markets remain strong and I believe consumer confidence will return, particularly with the completion of the presidential election likely to usher in a wave of hope and optimism - no matter who wins.  The implication in our business is that young start-ups will have a harder time accelerating revenue, but the fundamental pillars of the US entrepreneurial economy - VC capital, IT spending, advertising spending - won't radically dry up.  The CIOs and CMOs that I talk to and the survey data I read suggests budgets will be flat or modest growth rather than sharply down.

2) Web 2.0 - pop goes the bubble?  Billions of advertising dollars are shifting to new media venues, with online being the most popular.  This shift will continue to fuel speculation about what will be the most valuable online media properties and audience aggregation opportunities.  But although this shift represents a real opportunitiy for a few winners, I believe that the so-called Web 2.0 sector has been grossly over-funded over the last few years.  I think the weaker economy will cause this bubble to pop in 2008 when advertising budgets stop rising, there's more pressure on experimentation, and investors realize that customer acquisition economics are proving harder than expected.  The particularly strong inflation pressures on search engine marketing (SEM), as more advertisers direct their dollars to this performance-based category, will make this emerging problem even more acute.  Talk to any of the CEOs of the major SEM-based businesses and they will tell you about margin pressure due to the rising cost of traffic acquisition.  VCs who are over-exposed to the consumer/Web 2.0 sector may be in for a rude awakening.

3) Enterprise IT - the comeback kid.  Look at the last few IPOs and mega-exits in New England and you see a pattern:  the return of enterprise IT companies.  Acme Packets ($600 million market cap), Big Band ($300 million market cap), Bladelogic ($700 million market cap), Equallogic ($1.2 billion acquisition by Dell), Starent ($1 billion market cap) and Netezza ($750 million market cap) are signs that the post-bubble hangover IT departments have been suffering from has finally passed.  IT is willing to invest in young infrastructure companies and new technologies to improve efficiencies and modernize their capabilities.  These investment opportunities will continue in 2008, despite macroeconomic conditions exerting some pressure on IT budgets.

4) Wireless - slow and steady.  The chokehold that carriers maintain over the wireless market continues.  Meanwhile, advertising dollars are moving to mobile more slowly than expected due to ecosystem immaturity.  There is simply too much friction in the business for an advertiser to place a $1 million purchase (lack of inventory, fragmented and nascent ad networks, handset fragmentation - to name a few).  Thus, 2008 will likely be an incremental growth year for the wireless industry, not yet a breakthrough year.  Breakout conditions (pervasive 3G networks, video and rich content, a more mature advertising ecosystem) still feel 2-3 years away.  Good fodder for early-stage investors, but not an area of hyper revenue growth.

5) And our next president will be...who the heck knows??  This race is a toss up.  I would've predicted Clinton vs. Romney, with Clinton winning in a tight finish, but Romney has faltered despite all the money he's poured in and Obama and Clinton are neck and neck.  This will be an interesting race to watch, for sure!

That's it for now.  Let's see what 2008 holds for us all!