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.

#VC & Technology

Comments (Archived):

  1. RacerRick

    Now that we’ve got a downturn/possible recession, buyouts are slowing and happening for less money. So there go the VC exits (except for Fred who seems to have lots of exits).The only thing that entrepreneurs have going is that a lot of VCs have cash to spend. That may be the only thing that keeps this thing going through this mortgage-induced downturn/recession.Batten down the hatches indeed.

  2. Gordon J

    I like your optimism — it bodes well for us self-funded facebook/myspace/bebo/opensocial app developers.I’d be interested in your take on those startups whose primary business model is freemium/adsense. We are keeping costs contained (by developing in the cloud for one) but our main source of revenue is advertising… it’s likely to take a hit, right?

    1. fredwilson

      Yes, but the advertising that is the most recession proof is ROI advertisinglike CPC and CPA

      1. Steven Kane

        that is true, but with the caveat that some sectors are not recession proof, even in CPA and CPCbig case in point: one of the biggest segments for CPC and CPA is… financial services. mortgage sellers, credit card issuers, home equity line providers.

  3. Nick Patience

    Fred,Another data point that reinforces what you suggest about VC-backed companies may struggle with exists right now but that doesn’t necessarily follow that angels and VCs are backing off comes from the perhaps unlikely quarter of open source.We here at 451 Group just published our Q1 review of investment in open source companies, which points to the best Q1 in that area, with investments totaling $203.75m, up from $100.40m in the same quarter of 2007. Further analysis & data at the above link.Exits and investments, while linked, are different. After all, investors are generally thinking 3-5 years out when investing.Nick

  4. ceonyc

    Go bottom up on this… Do you know of any great companies that can’t seem to exit or get investment because of economic reasons?

    1. fredwilson

      If they are out there, I am hoping they will contact Union Square Ventures!

  5. burcaw

    So maybe exits will slow, but I don’t think angel activity will dramatically slow. Where else will the money be put to work? It’s not like they are going to get better returns on the market…

  6. Martin Edic

    I think there is a gap here that is not being discussed: lack of innovation in revenue models. Companies are getting pretty good at developing traffic but haven’t shown us any new models for monetizing that traffic. We have subscriptions, PPC, banner/CPM (fading rapidly in value), affiliate, lead generation and e-commerce. There has been a lot of innovation in the affiliate arena but little of that is venture-driven. Google owns the contextual market because they won’t let publishers use both Adsense and other contextual ads on the same page (a brilliant anti-competitive move because no one wants to risk a delisting). Lead generation is the big opportunity in a monetization play, particularly B-B lead gen where many companies would gladly pay significant dollars for qualified leads. The companies that crack that problem will have a big upside.

  7. Mat Atkinson

    I think that a recession is a chance for web-based businesses to thrive.For consumer oriented apps with an add revenue model, Fred is spot on saying that CPA and CPC advertising revenue will hold up best.For business oriented apps with a SaaS subscription model, the pay-as-you-go, nothing upfront, rapid deployment, rapid ROI model has huge appeal to businesses needing to tighten their belts.If a company has bootstrapped (like we have done at then a recession could be a great opportunity.

    1. fredwilson

      I think Mat is right about thisA downturn could be really good for certain startups that can offer more forless to advertisers, consumers, and businessesfred

  8. awilensky

    The valley VC’s are going to eat their term sheets for pursuing so many cloned business models. YASN and YAVSS startups will crowd the TechCrunch dead pool, and 2008 will be a blood bath.I am no high profile corporate strategist, but I had many opportunities to speak with several VC’s and valley undertakers that came through the door at France Telecom; I asked them, “what are you doing? There are umpteen companies doing the same thing in a questionable market, while at the same time, no one can convince any of you to cover vertical sectors that are starving for solutions. I also proposed a great product, that I carried around like a dead baby for most of 2007.You can’t tell these people anything. The ad supported social network market is sewn up by a few marque companies, and the video sharing is just an awful play. These investors will, therefore, reap what they have sown.I showed these VC’s surveys for potential users in a vertical that showed willingness to pay real subscription fees – not good enough, even with several diverse channels of revenue.Back up the truck, take the servers and the steno pads. And any other snack foods and the espresso machine while you are at it.

    1. fredwilson

      Are there any sectors/categories you do like right now?

      1. awilensky

        Web2o solutions for skilled trades, technical product services (includes specialized social networking solutions for highly technical equipment servicing communities), optimized mobile dispatch and workflow for independent automotive servicers.

      2. awilensky

        Oh yes, let’s not forget the research that I performed at France Telecom (that no one wanted to hear about, because they all bet on the wrong horses), brand monitoring solutions that tie into retailer and distributor inventory portfolios for decision support of differential inventory planning. This well documented research led several players, I mean, PLAYAZZZSSS, in the valley to call me bad names. But I am right on this call.Brand owners who can afford Arbitron and Gallup don’t need public corpus mining of sentiment, but the retailers and mid-market distributors do. there is not one solution for this sector – and judging by the idiocy in the VC valley community, there never will be.

      3. awilensky

        Fred, you are a thoughtful man, and an anomaly in the VC community; you use the technology that you invest in, and speak and write intelligently on the broad issues. But, the morons I met in SF bay area, Peninsula, Sand Hill, etc – I want to hit some of them. Ok, I am a mere working man, not a wealthy man, not even very successful in my trade as an independent consulting product channels analyst, but my research, surmises, and adjudications as to likely sectors are based on honest, sincere and detailed research and interviews. Even a simpleton like myself, with no university education, and otherwise well read and mature in my trade experience, could tell from a furlong away that the investments in all of these YASN’ s and YAVSS would amount to zero. Just look at the revenue results from Youtube and the side stepping shenanigans of Video egg.

        1. fredwilson

          I appreciate the sentiments and I do think that eating the dog food, as itwere, is critical to being a good investor. But I would like to debate yourassertion that I am an anomaly in the VC community. We invest with other VCsand I know quite a few very good ones. Like any business, there are goodpractitioners and bad ones. Unfortunately, you must have had your share ofthe bad ones.And on the subject of YouTube, I think it will turn out to have been abargain for Google at $1.6bn. They are taking their sweet time building therevenue side of that business, but they are getting there and it’s ahumongous opportunity, at google scale. And VideoEgg is one of the fewYAVSS businesses to have morphed into something that has a good chance ofworking. Yes, you are right that YASN and YAVSS will end badly for many. Butmaybe YouTube and VideoEgg aren’t the ones to point to.Thanks for the comment. I appreciate your frequent and always thoughtprovoking commentsFred

      4. Alex

        Are you looking to put some money to work in the iPhone apps sector? There’s going to be some great subscription models built on that platform.

        1. fredwilson

          Yes, we’d very much like to be investing in that platform. And android andany other mobile platforms that emerge. All you have to do is look outsidethe US to realize that mobile computing is the way of the futurefred

  9. coreyh

    Speaking as a bootstrapped startup founder, I’m okay with some tightening of VC dollars. 1) we are already pretty darn lean expenses-wise 2) blunting the “employee #15 at Paypal getting $60M for his unbuilt site based on credentials alone” (hypothetical) pattern is a positive thing for us. Overall, it feels like less silly money floating around means more time to iterate, do real engineering, UX refining and trust building rather than racing to get the flashiest thing up as quickly as possible.

    1. SutroStyle

      I second that. We are a bootstrapped company, fairly large, and we are looking forward for the end of VC2.0 funding. Rackspace and bandwidth will get cheaper among other things.

  10. Joe

    I believe many of the “Web 2.0” companies, including twitter, should have readied their platforms for licensing to the enterprise. This recent bubble was more about consumer startups than it was about enterprise startups, and perhaps the next wave will be more about the enterprise again (the open source investments cited by the 451 group in the first comment might be an indication of this).Best regards, Joe

    1. fredwilson

      JoeWhen we were investors in delicious we often talked about this as astrategy, but the discussions with enterprise customers always centeredaround a customized version of the service built and deployed just for them.Plus we would have had to build a sales force to go after that opportunity.We ran the numbers and decided we could build a more scalable, moreprofitable business by emulating google and others who have built largeenterprise user bases by just providing a free service that anyone coulduse. We never had the opportunity to test the model we imagined because ofthe sale to Yahoo, but I remain convinced that consumer facing servicesenter the enterprise all by themselves if they are good enough.Fred

  11. charlie crystle

    I think companies with real markets can grow into a contracting economy. Not all spending stops in a recession. It might be a bad time to invest in a new SUV company, but even something in the housing market could do ok. If your revenues are $5 million this year, it will take quite a while before you feel the effects, unless it’s a sector that 1)stops spending altogether 2) slows for startups or 3) is dependent on ads from a slumping category.

  12. Aruni S. Gunasegaram

    Great points. There are always two sides to a potential recession coin. I have bootstrapped (i.e., self funded R&D) so far and been out for about two months looking for angel financing. Despite having a couple of soft commitments, I am seeing the economic writing on the wall. I’m wondering if it’s even wise to take any money now or continue to find creative ways to bootstrap longer by finding other ways to make some income to put into the business.Living in Austin, Texas is not like being in the Bay Area or NY for that matter when it comes to Web 2.0/social networking/mobile companies. Most of our angels made money in enterprise software or semiconductors. Other feedback I’m getting relates to being too early. Early concept/idea stage investing doesn’t happen often down here. New parent/baby market is great and being validated by some interesting companies but until I have a social site up and running with a reasonable user base beyond our initial apps, people are cautious. The trick, as you know, is having the time/money to focus on building it to attract the users.As a serial entrepreneur, now is when the creative muscles get flexed in ways you never thought your muscles could move. 🙂

  13. WayneMulligan

    Cost Per Customer – most important metric to watch during a bull or bear market. Since it’s going to be challenging to squeeze more lifetime value out of a customer during a downturn, companies really need to focus on keeping their customer acquisition costs low. That isn’t to say people should stop marketing – marketing should ramp up in times like these. That’s when the smart players in a space can actually take market share from their competitors with bloated cost structures.-Wayne

  14. Steven Kane

    it strikes me that all the chatter about the effect on the venture investing markets of a weak economy and capital markets is about the effects on startups.unstated, i take it, is that cool or cooling markets and economies have no effect on venture firms and funds and partners?or on LPs?well, that can’t be the case… can it?if it is the case then this, i think, is a serious issue in vc investing and silicon valley economicsfor if that is the case then it would seem the motivations and incentives of the capital (LPs) and channels (VCs) and operators (the portfolio companies, both funded and aspiring) are improperly alignedconsider:given serious melt downs in capital markets and economies, and prolonged (reeeeaaallllyyy prolonged) absences of absolute, or even above-market, returns from venture capital as an asset class… and yet venture fund management fees and organizations and cost structures are not affected. layoffs at VC firms? unlike every other financial services institution, none. renegotiations of management fees? again, unlike everywhere else, no. pullback of capital commitments by LPs? none (that I know of).seems like LPs are uncaring (i doubt it) , unknowing (no way) or complacent (i guess so)seems like entrepreneurs are uncaring (no), unknowing (mostly yes) or powerless (not sure)seems like VCs are uncaring (not sure) unknowing (no way) or simply human beings, unwilling to volunteer to give back unearned rewards (likely)maybe this is simply a perpetual bias in the system. but given my experience with capital markets and capitalists generally speaking, i doubt it. maybe more likely, to quote bob dylan, “a slow train’s a coming” and “a hard rain’s gonna fall”?

    1. fredwilson

      There are quite a few VC firms that are struggling to raise funds right nowsteveAnd returns in VC in recent years have been quite good.So not everything you lay out as assumptions are correct.But your conclusion that this downturn will affect everyone is certainlytruefred

  15. Steven Kane

    hey fredwhat do you think is the performance of the vc asset class, overall?certainly some vc funds are doing well — please g-d let it be the ones i am invested in — but overall as an asset class, my impression is that returns are so-so at best (and, after fees, pretty poor.)your own posts on VC returns a while back seemed to indicate that the asset class is not performing well.and the fund-of-funds folks, research firms and investment advisors i know are pretty consistent — they think VC asset class overall generated less than 8% IRR last ten years, and they predict it will not even do that well in this current 10 year period. which isn’t to say they have stopped investing in VC (though some have or are stopping). but they now believe they have to be in the top decile of funds to make investing in VC worthwhile – until recently the rule of thumb was “get in the top-quatrile”

    1. fredwilson

      I think most of that is trueIts hard though because so much of the overall dollars invested in vc were invested in 99/00/01 and we have not seen final returns on those vintages yetIt is exactly those vintages that have been producing distributions in the past three years. That is not to say that those vintages will ever be goodBut three years ago, the mean for those vintages looked to be 50 cents on the dollar. It might be 100 cents on the dollar now and may end up at 125That will have a meaningful impact on the 8pcnt number you cite and could push it to mid teensFred

  16. Uday

    regarding “lot’s of users & no revenue”:I think this type of companies are going to have trouble,as Deepak mentioned. The reason is that if you have lot’s of users, you need lot’s of infrastructure. If you need to maintain lot’s of infrastructure, you need lot’s of cash. If there is no revenue, well, either investors has to pour more money to keep the user base OR the company will go down the tube.I am NOT sure how a company with NO revenue can survive in the recession! (even it has lot’s of users).-Uday.

  17. Toujours_fidele

    With all this doom and gloom how about a nice big fat positive play?Networks now charge more per thousand viewers online than they do over the airwaves, where the average for a primetime show is about $25. Analysts put the online rate anywhere from $35 to $50 per thousand, though there are millions more potential traditional TV viewers.Advertisers pay more online because there is a better accounting of how many viewers see the ads and an extra benefit that an impulse to purchase can be acted on with the click of a mouse.”For an advertiser, you’re getting a clear performance result,” said Bob Davis, a Web investor and former CEO of search engine Lycos. “No matter what the click-through (rate) they get, it’s infinitely larger than the click-through they get on TV. The click-through they get on TV is zero.”The ‘upfronts’ – advanced sales of air time, totalled $9.2 billion in 2007 but will not reach that in 2008.Whatever the amount, say $8 billion, what if you could turn that $25 per thousand prime time to $35 to $50 per thousand increasing the value of the ads to advertisers by turning zero click through rate TV into instant buys and interactive info requests?The ratio of increase in value would be roughly the same across all time slots. It may even increase the value of some time slots way beyond where they are now.The minimum return would be somewhere in between $8 billion at worst, $11.2 billion median and $16 billion in 12 months. 140% to 200% in 12 months.Of course you’d probably buy options on future years for peanuts and be in a position to dominate the market.There is a way to turn TV viewers into click throughs without the co-operation of the networks and sell click throughs and actual completed transactions to the advertisers. You control the online click-throughs and also handle the transactions from the one-click follow up buys. There are all sorts of other applications like multiplayer interactive TV games and live TV mass auctions.There’s a lower cost higher risk small market play but what the heck if it’s a go it’s all go, but even if you don’t own the airtime you can sell the click throughs and click buys.It cost’s peanuts to enable and operate the technology and it works on TV, Cable, Radio on any and every network without any help from the network or advertisers. The vast majority of TV viewer would and could do it, without buying any gadgets or paying subscriptions. Its secure end to end and has many other appealing features. If an advertiser doesn’t want to buy the click throughs and buys, their competitor who didn’t pay for the ad just might.I haven’t even considered an exit strategy but I imagine there are a few healthy options.If you think it would be a fun play let me know.