Startup general interestVenture Capital

Keeping going through the turmoil

By August 9, 2011 3 Comments

The world is a chaotic place right now with riots in London, biggest ever one day falls on American stock markets, debt downgrades in the US and unprecedented steps from the European Central Bank to bail out the peripheral Eurozone economies all happening in the last week.  The catalyst for these events has been the declining prospects for economic growth and I was asked this morning in an interview with the Guardian what I thought the impact will be on the startup world and the tech bubble that we are in at the moment (I will post a link to the podcast when it is online).

Thinking about it at the time, and in subsequent conversations my view is as follows:

  1. Tech valuations have recently been spiking up to levels that aren’t sustainable in the long run.
  2. Those valuations have been driven by the IPO market and if the current public market turmoil continues the flow of new IPOs will dry up and those that do make it through will be at lower valuations.  VCs value private companies in part by looking at public market valuations and hence the lower valuations will trickle down to startups. 
  3. So I think most likely there will be a correction in values, but it won’t feel like a bubble bursting.  Rather, a smallish number of public internet stocks will see drops, and private company valuations will fall slowly and largely out of the public limelight.
  4. Meanwhile the technology that all these public and private internet companies have produced will continue to be more and more widely used (two stories from Techcrunch this morning make the point: ecommerce grew 14% in the last quarter and Walmart has just announced plans to use social media data in its site)

The upshot is that share prices for technology companies have become decoupled from the underlying value that has been created, but that even whilst there is a correction in the share prices the process of value creation will continue.  Share prices will therefore eventually drop to their natural level (and may even dip below it) but eventually they will start to rise again – driven by the underlying value creation.

The key for startups is to be aware that the world for them will be different going forward, and the key to that is to be prepared for a tougher fundraising environment.  When the overall economy is in recession it is much more difficult to build businesses.  Consumers and businesses have less money overall but are still faced with similar expenses on core items (rent, food, raw materials, products from existing suppliers) so new products and innovations face a disproportionate share of the cuts.  When it is more difficult to build businesses the risk for investors goes up and many will take longer to make investment decisions and look for more evidence of success before committing.  Others will focus on their existing portfolio and make few new investments.

The conclusion therefore is to look again at budgets and make sure they make sense in this new environment.  For many that will mean less aggressive growth plans and for some it will mean cuts.  The sooner that changes are made the less severe they will need to be.  Right now I think it is appropriate to start thinking in this way, but I would hold off from implementing changes for a couple of weeks.  There is a chance that the markets just bounce right back, so I would take a little time to be thorough and then be ready to adjust to the new world in September if things haven’t improved.

The fundamentals for technology, innovation and startups remain very strong.  The pace of innovation continues to increase and mobile, social, payments, and cloud are all set for massive continued innovation over the next five years.  You just have to be smart about surviving the tough times.

We’ve seen this movie twice before now, after the NASDAQ crash in March 2000 and the collapse of Lehman Brothers in 2008.  Hopefully we have learned from those experiences and fewer startups will suffer this time round.

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