We’re often asked how the malaise in the global economy affects our appetite for new deals. These past few months have been harrowing for nearly every segment of the economy. Governments across the world are coordinating in an effort to intervene aggressively and revive the credit markets. You would be hard pressed at this point to find people who are not worried about the state of the economy and its impact on their immediate community.
Eight years ago, the technology bubble that preceded that crash was spurred by technology investors who plowed billions of dollars into Internet companies with questionable business models at unsustainable valuations. This time around, the crisis unfolded from a different source: a housing boom that fueled an insatiable desire for debt. Certain financial institutions sold exotic securities that masked the true financial health of the borrowers. As the de-leveraging began, financial institutions desperately tried to bolster their balance sheets by selling assets. Instead of strengthening the balance sheets, companies lost all their sources of liquidity, their stock prices plummeted, and they were forced to rely upon the lender of last resort: the US government.
The meltdown in the financial services sector has quickly flowed into other areas of the US economy such as the automotive industry, travel and hospitality, and retail. We’ve also seen how closely coupled our economy is with the economies of Western Europe and the emerging markets. Now that some our largest institutions have either failed or approached bankruptcy, we’ve all been asked: do VC funds still have capital to invest? What type of future awaits early stage startups that rely upon the capital markets to fuel their growth?
First and foremost, our fund is very much open for business. We have only invested a minority of this fund’s capital. We have plenty of capital reserved for those investments that we feel can succeed in the toughest economic environment. The majority of our fund’s capital is from larger institutional investors whose capital commitments to our fund comprise a small fraction of their overall alternative asset allocation. We invest equity capital so we are not affected as directly by the debt markets. We also have the backing of Greenhill & Co., which is one of the few investment banks that has continued to expand at a time when most of its peers are struggling.
Some of the greatest opportunities for VCs and entrepreneurs arise when other investors and entrepreneurs are skittish. The vast majority of our investments in SAVP, our predecessor fund, occurred between 2001 and 2003 – a timeframe when most funds were struggling to keep past investments afloat. We have had numerous exits since that timeframe and the remaining 8 SAVP portfolio companies currently generate an aggregate of several hundred million in revenue.
Of course, the last recession was not without its rough patches. Many of SAVP’s portfolio companies were forced to reconfigure their business models to survive through a weakened economic environment. We anticipate similar challenges in the current economic environment. As IT budgets and marketing budgets tighten, we encourage our entrepreneurs to develop products and services that generate quantifiable “hard dollar” ROI to their customers. As the capital markets dry up, we are more cautious about reserving capital for follow-on investments and keeping costs to a minimum.
In terms of new investments, we closely adhere to the core tenets of our overall investment philosophy: capital efficiency, significant market size, and exceptional management teams. We seek co-investors who will work with us to support the companies through challenging economic environments. We also assume that IPOs will remain an unlikely outcome and adjust our risk-return assumptions accordingly.
Current market disruptions give entrepreneurs the opportunity to play a leading role in the recovery of our economy. Innovation, as many historians have chronicled, can be a catalyst for a growth in industries that can no longer afford to maintain the status quo. This can be in the form of IT innovation to reduce the soaring costs of health care or financial innovation to address the current liquidity crisis.
The great inventor and futurist, Ray Kurzweil, envisions a “Singularity” event occurring in the 21st century – a point where technology will appear to grow at infinite speed and where non-human intelligence will exceed human intelligence. While we may not share Kurzweil’s abilities, we do believe that technology-enabled innovation will continue to see explosive growth throughout this century.
So, despite the short-term economic constraints, there is much to be excited about our primary mission – backing world-class entrepreneurs who apply innovation to solve key business problems. We look forward to playing our part in this story.
If you would like more insight into our investing philosophy take a look at our blogs. Read Steve Brotman’s newest posting entitled “Try Peanutbuttering“. Brian’s blog can be found at http://www.ny-vc.com.