Some argue that 2008 will see some down rounds and a wave of acquisitions from VC-funded companies. I agree that we are going to see a shakeup for a few reasons. Business Week recaps VC activity over the past few years:
VCs will have sunk more than $40 billion worldwide into startups in 2007, up from $37.3 billion in 2006, according to market researcher Dow Jones VentureOne. That’s still well short of the $56 billion VCs plowed into startups in 2001, but up by more than a third compared with the Death Valley days of 2003 and 2004.
Among the hot investment areas in 2008, VCs surveyed by the NVCA pointed to
- clean technology,
- media and Internet companies, and
- biotechnology outfits.
(…)
And the median time from a startup’s founding to its IPO stretched to nearly eight years during the first three quarters of 2007, up from about six in 2005 and four in 1999. That means VCs will need to crack the whip on underperforming investments. “You’ve got to force them to make a move or get rid of them,” says NVCA President Mark Heesen.
A tepid IPO market makes it harder to reap the kind of returns that VCs count on to offset the bad bets in their portfolio. They made at least 10 times their initial investment on just 27 of 135, or 20%, of their portfolio companies that were sold for disclosed amounts through Dec. 21, according to the NVCA and Thomson Financial.That’s slightly higher than in 2006 but well short of the 45% of deals in 2000 that yielded a tenfold or higher return.
(…)
However, tighter credit has curtailed “rollup” buyouts in which private equity firms purchase a tech company that’s strong in a given area, then buy smaller startups that complement it to create a new company. That has closed down one avenue for VCs to cash out of their positions. “There’s certainly going to be less leverage available,” says Farrington. “Money won’t be as easy in the future, and that usually hits the M&A market at some point.”
(…)
As VCs try to sell or take public their best-performing Web companies, and foster new ones for the future, they’ll need to keep a close eye on how the performance of the U.S. economy affects online spending. If consumer sentiment keeps eroding and business confidence slips, investors could discount Web startups on lower expectations for growth. “When you’re buying a startup, you’re buying the future,” says Will Price, a managing director at Hummer Winblad Venture Partners. “If there’s a fall in business or consumer sentiment, there could be a falloff in the online ad market. The difference between a company growing at 50% and 15% is huge.”
Here’s something else to consider about those hot Web companies: Some still haven’t settled on a business model. Social networking site Facebook’s rough start with its Beacon purchase-tracking ad system, (BusinessWeek.com, 11/30/07) for instance, may dampen enthusiasm for companies that are banking on selling ads on the networks. “People are going to have to be extremely careful about how they monetize these Internet communities,” says StarVest’s Farrington. “People are going to have to be careful about killing the goose that laid the golden egg.“
It will be very interesting to see how this all plays out. Bear in mind that one of the best remedies to any [perceived] bubble is the expectation that things will go awry. The 2000 Nasdaq crashed largely took place because no one expected the music to stop.
Some projections and conjecture on all of this:
- Clearly, startups who are touting the latest social networking site or file sharing platform etc. will face challenges, but we’re not saying anything new.
- But, even existing players in these spaces who have already gotten VC funding might not be able to raise any additional money. For example, say last year, VC #1 invested $3M in a company at a $7M pre-money for 30% of a $10M post-money company based on hype, growth and the promise of tomorrow but in the year since not really demonstrated a revenue model or now faces 10 competitors (let alone 100 or 1000), I do not see the same VC pouring in more money. I also doubt VC #2 would come along and agree to doing a round at $15M or $20M because the hype is not over something else and there is much more competition.
So will VC #1 and founders accept a down round? I’m not sure. The founders will be pushed aside, or the VC will balk and move on to the next big thing. So the company shuts down. This is why VC money is the kiss of death sometimes and you should avoid it if you can… but VC is a necessary evil.
- But for companies who do not have complicated capital structures, I think raising financing becomes easier, especially if they have overcome the first challenging 6-24 month proof of concept period. Speaking from experience, we’re starting month 25, have never had any outside funding, and have grown 10-20x since June 2007. To say that it is easier to raise money on better terms is a bit of an understatement, the challenge lies in finding the right investor (right geographic, stage investment profile).
- The point is, while macro level factors change, the micro environment landscape remains the same: the best companies will get attention… especially with an economic slowdown affecting offline advertising more than online activity, I certainly expect a lot of M&A activity from media and tech companies looking to further digitize their portfolios and become more interactive. Apparently, we’re not alone in thinking that there will be more M&A.
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