12/18/08

For VCs It's Deja Vu All Over Again

It seems like the Venture Capital (VC) sector has just emerged healthy again from the tech bubble, when now it faces a potentially greater challenge as it deals with larger systemic financial problems. A Survey done by the National Venture Capital Association (NVCA), and reported on by the Associated Press, paints a bleak portrait for the next several quarters.

http://tech.yahoo.com/news/ap/20081217/ap_on_hi_te/venture_outlook

During the period of 1998 to 2001, Venture Capital was investing in "new business models" associated with the emerging information technology economy. Investment decisions were clearly flawed by greed and speed and a lot of dubious business concepts were funded. Everyone has heard the legends of multi-million dollar investments made into business plans drawn on the back of paper napkins.

I'm not so sure about the legends, but one thing I am more certain about is that there were some pretty important business models that have emerged from that period. Some models that were expected to be dominant became fairly minor relative to some surprising ones. Most of the big bets were placed on e-commerce because everyone was going to buy online. People definitely buy online, but not at the rate expected - and a lot of investments went bust. Remember trading networks? A lot of capital was placed on this model, and it never really materialized. Whoda thunk that the Cost-per-Click (CPC) ad model would be the single most valuable revenue model of the information economy? Investors in Google (GOOG-Q) got it right. I remember the buzz surrounding the Application Service Provider (ASP) model. Although the details of that business model may have been flawed, it has spawned some key variations such as Software as a Service (SaaS), which may be a model that ensures survivability for many software companies during this brutal economic period. The bottom line is that, although the VCs made some dubious investments, the era spawned a bunch of tough-as-nails tech companies with cashflow, earnings, visibility, and , frankly, a lot of happy investors.

The ASP model itself could be considered an ancestor of Cloud Computing which many, including myself, believe could be a foundational element to IT innovation when capital budgets are tight. And according to the NVCA survey, there is likely to be very little IT venture funding to go around for a while. As VCs continue to deploy a greater share of increasingly constrained capital towards cleantech, venture investments in information technology should decline. According to the survey and in my opionion, easily commoditized high risk technology like chips, firmware, and hardware should experience challenges, along with consumer facing innovation in media and entertainment (I think that social networking fits into this category).

From an IT perspective, innovation in mobile technology should continue to receive VC funding, as well as infrastructure plays that improve efficiency. Storage, virtualization, security, and network capacity should be general categories that may continue to attract VC capital. Although most capital is likely to be follow-on investing.

In general, start-up funding should be increasingly difficult to find throughout 2009. Entrpreneurs probably need to find ways to bootstrap and self-fund. As a result, we should see a few more greybeards with previous success among the next crop of upstarts. I think that we may have seen the last of the 25-year old billionaires for a while.

The NVCA survey infers that VCs are likely to try to fund more established IT operations with cashflow and scale that are cheap. There is not much venture in that capital. I think that VCs will struggle to compete with Private Equity funds and even some of the junior public indices for these type of deals.

Again, I believe that public companies with cash on balance sheets and liquid stock should be in great position to gobble up some pretty good venture enterprises cheaply, as VC capital dries up. Where there is pain, there is opportunity.

No comments:

Post a Comment