How Will Tougher Economic Times Impact The Web?

The front page of the NY Times Week In Review section today looks like this above the fold:

Recession

The associated article by  Peter S. Goodman talks about how a US economic downturn might play out in the worldwide economy. I’ve gotten a lot more emails recently from readers who want to know what I think about the economy and what impact a slowdown would have on the web and web startup scene.

First, I have been concerned about the US economy for a while. My post yesterday about oil based trade imbalances is part of my concern. I am also concerned by large and sustained budget deficits. The twin budget and trade deficits have put the US dollar and US dollar denominated securities under pressure. Huge wealth buildups are occuring in other parts of the world, most notably the middle east, russia, china, india, and other rapidly developing economies. To date, that wealth has been reinvested in the US. But that may not continue.

Add to this primary concern the secondary concerns related to our housing and mortgage mess and the inability to lower rates much more to stimulate the economy and it certainly looks like we are in for some tough times here in the US in the coming years.

I suspect these tough times will be reflected in our capital markets. Certainly they will be felt in the public markets for US equities and I believe we are already seeing that. Last week saw the pulling of a number of public offerings that were planned for the fourth quarter. The IPO market is weak for sure.

The buyout/private equity market is also undergoing some changes. Debt offerings have become much more difficult in the wake of the subprime mortgage mess. Banks are focused on risk and risk management, as they should be. Buyout valuations are coming down as a result.

Will the venture market see the same choppy waters? It’s hard to say. There is a lot of money that has yet to be put to work in venture funds right now. Venture deals are not dependent on loans so the debt market is not likely to be a factor. It is true that silicon valley is starting to get more cautious. I’ve seen a number of stories lately that firms such as Kleiner Perkins and Draper Fisher Jurvetson are taking a more cautious stance toward web applications and services (web 2.0 in the vernacular). That’s a good sign. If silicon valley can self correct without a meltdown like last time, we are all so much better off.

There’s something else at work however. The web itself continues to be a major economic force, both in the positive and the negative. The web is disrupting and wiping out margins in industries like music, film, newspapers, and increasingly sectors like personal finance and software. But the web is having an equally positive effect in sectors like advertising and direct marketing. We (me and my colleagues at Union Square Ventures) believe that the web is accelerating its transformative power and that businesses built around a web foundation will continue to take share of the worldwide economic pie.

So I suspect that there will continue to be a healthy supply of capital targeted at web applications and services for as far as I can see. Capital chases returns. And the web appears to be an increasing returns economy at this point in time.

What is probably going to happen is the hype cycle will die down. The capital markets, including possibly the M&A market that has been driving returns in the web sector, will be less attractive. And we’ll have to build our companies for the long haul. Which is as it should be. Venture capital is long term capital and those that are patient and are prepared to hang in there through up and down markets will be rewarded.