I have been asked by many friends and former colleagues about the implications of the current credit crisis on my industry. My answer is pretty straightforward: I am not too worried.
There are three angles to consider if you are a venture capitalist:
- Investors/Limited Partners – these are the people whose money we invest. Since we collect money from our partners just before we invest it (“just-in-time investing”), not up-front at the time they make their full commitment to the fund, there is some risk that partners will not have cash on hand to back up commitments, especially if they are large institutions wrapped around the credit crisis. Luckily for us at Meakem Becker, we have a large, diverse set of limited partners, most of whom are wealthy individuals, not institutions; my analysis indicates that our risk exposure is low here.
- Portfolio Companies – the companies in which we invest are likewise largely immune from the crisis. In the earliest days of the crisis, in early 2008, there was some exposure to Auction Rate Securities (ARS) that caused many portfolio companies heartburn. These short-term investment vehicles were sold as a higher-yield alternative to keeping money in a savings account or money market, but ran into a liquidity hiccup due to their structure (remember: there is underlying risk to EVERY investment vehicle, no matter what your broker/advisor says!). That early episode woke up our industry, and put VCs and startups on notice about how to manage cash. We have escaped that miniature liquidity crisis, and are smarter for it. With the exception of needing to be capital efficient, as I wrote about a couple days ago, risk to portfolio companies is low.
- Overall Market – as Alexander Haislip points out in his post, How Lessons from the Dotcom Bust are Helping VCs and their Portfolio Companies Today, the IPO market has been shut down for some time now, and no smart VCs or startups count on it as the primary source of exit. VCs and startups need to focus on building companies of lasting value – not on building companies to flip quickly. When a company does build value, M&A and IPO come naturally, largely regardless of short-term market instability. This is the area that undoubtedly has the greatest risk, but I would still rank it as low-medium.
Another good sign, and cause to relax, is that Oracle of Omaha, Warren Buffett, has decided to put his money into the market, and we all know that is typically a sign that we are at, or approaching, the low point in the valuation cycle.
On the contrary, rather than being worried, I am optimistic about what the credit crisis means for the venture capital industry. I say this at the risk of dancing on the grave of a significant part of the US economy, but trust me, I am bullish about the US recovery from this crisis. The strength of the United States economy rests largely on the growth of small businesses and new, innovative companies – and we invest in one half of that dynamic duo. As investors look for places to invest their cash, and think about portfolio theory, it is just like a statistical mechanical equation, and with less channels to invest, our statistical state of early stage venture capital should get a greater share of that cash in the future. I look forward to raising the next MBVC Fund!