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Sub-prime fallout yet to impact venture capital

By November 5, 2007 January 18th, 2008 No Comments

Posted by mobile phone:
Every other day I get asked whether the fall out from the sub-prime crisis is affecting our business as venture capitalists. I always answer ‘No, not in any significant fashion. Crises like this always take a long time to filter through to our end of the market but I’m hopeful we will ride this one out’.

There are two ways in which crises at the macro level impact VCs and entrepreneurs – one is demand for the products and services our companies provide and the other is demand to invest in venture capital funds themselves. Unlike the stock and money markets changes in both these areas tend to play out quite slowly. Remember that we invest in fast growth businesses that usually can’t support much debt – so unlike our private equity brethren there is no direct impact from the tightening of the credit markets.

Demand for the products and services of our portfolio companies and by extension our ability to exit them at good valuations is linked to overall economic performance rather than any individual sub-market, so unless the credit problems spill into the wider economy and cause a general recession we should be ok. Despite the crisis claiming it’s second major investment bank CEO over the weekend as I write this post my best guess is that the fallout will be relatively contained. We are also somewhat further protected because we invest in high growth areas of the market, so a general slowdown to say 2% growth has proportionately less effect on us than on larger and more mainstream businesses. Obviously a full on recession is bad news for pretty much everybody.

The impact that I have seen so far has been limited to one of our portfolio companies that peripherally deals in consumer credit and a couple of exits that fell through when private equity buyers saw the debt side if their deals fall away.

The story is somewhat similar when it comes to demand from institutions to invest in our funds. The first point is that they mostly operate annual allocation cycles so the impact of the current crisis won’t be seen until next year. The second point us that the size of those allocations is geared more than anything to the stock markets – and so far they are holding up very well.

Most institutions set allocations to venture capital as a percentage of assets under management, and that percentage is rising over time as the asset class becomes more mature. So unless we see a sharp fall in the stock markets I wouldn’t expect the current problems to have much impact on the ability of VCs to raise funds. This seems to be reflected in the market where a lot of people are successfully raising new funds.

For these reasons I remain bullish on the European VC/startup ecosystem.