Battening Down The Hatches

Dean Takahashi, who I met yesterday, has a post that made techmeme about the numbers coming out on venture investing, IPOs, and M&A. To quote:

Successful venture exits are becoming scarce. Yesterday, the National Venture Capital Association reported the first quarter saw only five venture-backed initial public offerings worth
$282.73 million, down dramatically from 31 IPOs worth $3.04 billion in
the fourth quarter. Mergers and acquisitions are also on the decline,
with just 56 in the first quarter compared to 83 in the fourth quarter.

At the same time, angel investors have become more cautious because of the economic volatility, according to the 2007 Angel Market Analysis released
Tuesday by the Center for Venture Research at the University of New
Hampshire. That’s significant because angels account for 39 percent of
investments in seed-stage start-ups.

What’s more, the Silicon Valley Venture Capitalist Confidence Index,
an index that tracks the confidence among venture investors, fell to
its lowest level in the past four years in the fourth quarter of 2007.
You can expect that this confidence fell further in the first quarter,
with the collapse of Wall Street bank Bear Stearns earlier this month.

All of this is true. There is no IPO market right now for venture backed companies to speak of. M&A buyers are wary and while deals are getting done, a lot of deals are blowing up too. I don’t know about the angels and VCs backing away. We aren’t seeing that so much right now. I had lunch with a well known early stage VC in Silicon Valley yesterday and he told me he’s signed four term sheets in the past month.

Dean quotes four silicon valley VCs:

“I’m fairly bullish,” said Jason Green, a partner at Emergence Capital. “The broader economy is tough for consumers. But I’m not seeing signs of change in valuations of start-ups.”

But it’s time to check out contingency plans. Deepak Kamra, a partner at Canaan Partners, said, “Companies that are built on having lots of users but no real revenues won’t last. That all changes with the downturn.”

More companies are drawing down tranches on previously raised
rounds. “Smart companies are battening down the hatches now,” said
Thomas Cole, a partner at Trinity Ventures. “If they can raise more money, they will. That’s like putting more gas in the tank.”

But you can’t look at the glass as half full if market conditions
continue to deteriorate. “At some point, you have to realize that when
times are bad, they’re bad for everyone,” said Ryan Floyd, a partner at
Storm Ventures.

I would second all these sentiments. Ryan’s quote reminds me of what my partner Bliss McCrum at Euclid used to say "when they back up the trucks they take all the furniture". Nobody is spared in a bad economy and that will be true of the venture capital business.

I would push back a little on Deepak’s comments. If a company has lots of users and no real revenues, but keeps its burn rate low and can continue to ramp its user base cost effectively, I think the economic downturn isn’t necessarily bad news for them. After all, if you have no revenue, you have no revenue to lose when your customers stop placing orders.

That last bit was sort of tongue in cheek. I don’t want to downplay the importance of revenue and business models. But in my mind, the single most important thing is not revenue in a time like this. The most important thing is cost structure. Thomas Cole says "smart companies are battening down the hatches". That’s right.