VC Update: Navigating a Difficult Economic Environment
The National Venture Capital Association recently noted that there were no venture-backed IPOs last quarter. The last time this happened was 30 years ago. The M&A markets have cooled down somewhat as well. In the first half of 2008, there were 120 M&A exits for venture-backed companies, down from 169 in the first half of 2007.
Is it all downhill from here?
There are numerous case studies of technology companies that continued to grow during recessions. Google, Salesforce.com, and WebEx are prime VC-backed examples of earlier recessions. Similar examples from earlier recessions include Apple, Microsoft and IBM. Red Hat has continued to sustain 30% quarter-on-quarter growth this year (corporate customers are now considering lower cost open-source options as their budgets tighten).
We believe the venture capital industry can fuel high growth startups even in the toughest economic environments. Many successful investments in our prior fund continued to grow well after the collapse of the last Internet bubble. Those companies that succeeded demonstrated a strong ROI for their customers. They addressed a pain point that could justify additional spending in spite of an economic slow down. The companies also often had short sales/product cycles, high gross margins, and recurring revenues that could generate enough cash flow to protect a company from the most severe downturn. In many cases, these companies targeted markets that were countercyclical.
Most importantly, the entrepreneurs of these companies exercised prudence in raising and deploying capital. This focus on capital-efficient growth paid off handsomely once they were in a position to take advantage of a stronger exit environment (something their competitors were not able to do as they ran out of cash too quickly). With few exceptions, those companies in our industry that raised more capital than they needed also lost their focus on customer ROI and carried exit expectations from investors that were not in sync with market realities.
We have employed a similar investment philosophy in this fund. The entrepreneurs we have backed so far have shown a keen awareness of their customer’s key pain points and how they can apply technology to solve these problems with a quantifiable ROI. Their companies have recurring or repeating revenue models and capital efficient growth strategies. They all are addressing multi-billion markets that are often countercyclical.
It is important to note that these set of characteristics do not guarantee a company will make it through an economic downturn. We must be weary of survivorship bias. For every company that makes it through the tough times, many more will struggle or fail. At times like this, however, companies should strongly consider multiple strategies to maximize their chances of riding out the storm. We continue to actively explore new investments that fit this philosophy and believe that some of the best years are ahead of us.
Steve Brotman is a Managing Director of Greenhill & Co, and co-founder and co-head of Greenhill SAVP. Prior to founding SAVP in 1998, Steve was the founder, CEO and Chairman of AdOne Classified Network, one of the nation's leading classified ad web sites which merged with Powerdz to become PowerOne Media.
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