As a follow on to my post on the impact of the financial crisis on the software markets, I wanted to take a quick look at the world of software start ups and the venture community. Now no one can doubt that we're in a crisis and that the crisis is BAD ("dummies guide to the crisis") but what does that really mean for current software start ups and for new ventures seeking funding over the next 12-24 months?
There's no simple answer to this question just like there's no simple solution for the crisis. Main stream investing, financing, banking are in a mess but what about "alternative" investments like VC funds? The core of the crisis is not linked to VC funds at all but that's not the whole story. In general VC's are becoming more concerned as the crisis deepens and are worried, especially by the potential difficulty raising future funds. You see funds often include investments from banks, pension funds, insurance companies, mortgage lenders, etc. Banks and insurance make up about 20% of all VC funds and certainly they won't have the capital to invest in future funds in the near term anyway. Freddie mac and Fannie Mae both invested in VC funds too. VC funds also often include large companies and wealthy individuals who have been severely hurt by the devaluation of the markets and in some cases won't even be able to honor previous commitments to existing funds.
The state of the economy also limits exit strategies for start ups; we've seen almost no IPO activity this year (for example there were 31 VC backed IPO's in Q4 2007, 5 in Q1 2008) and even the merger and acquisition frenzy has slowed so VC's are worried about how they get returns on their current investments. In some cases this will require the VC's to continue to invest in a company to insure they maintain the potential of future returns, severely strapping current funds. In the extreme the funds would have to sell off their stake in portfolio companies to secondary firms at a discount.
The news isn't all bad though. Several well established VC's have already raised large funds this year, including Battery Ventures, Sequoia Capital, and Austin Ventures. The problems will likely put a crunch on newer, smaller and less established VC's though. This could be especially rough for Leverage Buyout firms (LBO), who rely on loans to leverage their deals.
So what's my advice to start ups:
- Raise new rounds earlier it will take longer
- Be more cautious on burn rates
- Don't plan on IPO's or M&A activity for the next year
For good start ups:
- it will be easier to hire
- office space will be more available and cheaper
- follow on rounds could be easier as investors are drawn to quality
- fewer start ups means it'll be easier to get PR, media and analyst attention
There is VC funding out there and for new ventures with a very real business plan as well as high quality start ups who have built a solid business that money will continue to be available during the crisis.
