Update: Not sure if this is a good thing, but Charles Krauthammer completely agrees with me:
Imagine that tomorrow your doctor informs you that you have a debilitating disease. Imagine further she tells you that this malady might mildly improve if you immediately underwent dramatic and invasive surgery. It also might get worse. Alternatively, your doctor tells you that your health will invariably recover--perhaps significantly--if you wait. She just can't say when. The disease isn't fatal, physically. But psychologically it causes frustration, elegiac anxiety, self-doubt and a profound sense of lost opportunity. Your choice is take radical steps in the hopes of a potential recovery today or let the passage of time improve your odds of success.
This situation--acute investor paralysis--is what's facing investors and entrepreneurs today, particularly those located in the US. The first option to deal with this malady is to jump in with both feet and invest aggressively into an environment notable solely for its unpredictability and the second is to horde cash and wait for a clear horizon, because, essentially no one can seriously lay claim to a credible theory of tomorrow's investment environment.
On July 9th, The Wall Street Journal highlighted this ambivalence as these sentiments were conveyed at the recent Allen & Company media mogul conclave in Sun Valley. In discussing the troubling European economy and expiring US tax cuts, the Journal noted WPP CEO Martin Sorrells remarks, "People feel that things are uncertain," and Liberty Media Chairman John Malone echoed the feeling, telling a group of reporters Thursday morning that he believes the high levels of debt held by the U.S. and other governments could hamper growth for years to come."
faced by sovereign governments too fractured to act and to continue their US investment programs; all of which is overshadowed by a global financial services industry in disrepute, virtually panicking at the proposed new set of rules it needs to adjust to and unwilling to extend credit under practically any
Others are starting to notice the same thing. In a recent article, Bloomberg columnist Amity Shlaes defines the uncertainty and lays the blame squarely at President Obama's feet. She writes at length in a recent Washington Post article:
"But change that is too arbitrary and too frequent petrifies firms,
especially before their rules have been tested in the courts. As
Verizon Communications chief executive Ivan Seidenberg
noted recently in a Business Roundtable speech: "By reaching into virtually
every sector of economic life, government is injecting uncertainty into the
marketplace and making it harder to raise capital and create new
This analysis echoes those of Depression-era entrepreneurs. In 1938 Lammot
du Pont, head of the eponymous chemical concern, spoke of a "fog of
uncertainty" slowing business and noted in the company's annual report that
arbitrary government always slowed business down: "by land and sea the
universal practice under conditions of fog is to slacken speed."
So investors all along the value chain are doing the only rational thing: they are languidly stepping into wet concrete and letting it harden around their ankles. The numbers in the venture sector tell the tale in microcosm what the macrocosm is experiencing. According to the most recent data from the NVCA, venture fundraising dropped 31% in Q1 2010 to a total dollar figure of $3.6 billion. More ominously, the number of LPs (i.e., investors in funds) plummeted by 44% during the same period. Investments in follow-on funds exceeded first time funds by a wide margin, favoring larger and more established groups who tend to avoid early stage risk. Only safe bets, please.
Unsurprisingly, direct investors are less willing to part with their cash. During the first quarter of 2010, venture investment was an anemic $4.7 billion. It's worse than the numbers show, however, because masquerading behind the data were two outlier growth sectors: biotech and cleantech. Regarding the latter, this is a sector with inextinguishable hype despite no evidence of providing a venture return. The biotech sector remains vibrant strictly because there are exit opportunities: large players have effectively outsourced their R&D function to the startup community, which reduces their risk but increases the price they pay for proven technology companies. It's an ecosystem that works for both predator and prey. All the other sectors were flat to down.
Recently released fundraising numbers for the first half of the year also provide a picture clear as mud. According to Dow Jones LP Source, for the first six months of the year, $7.5 billion was raised by 72 private institutional investment funds, a 13% improvement over the same period last year. But dig deeper into the numbers and you'll notice that one fund, Sequoia, represented $1.0 billion of that total, or 12%. Moreover, that fund was targeted exclusively at opportunities in China.
The consequence for US entrepreneurs is that for now and the foreseeable future they will be faced with an ever-shrinking pool of risk capital to tap for startups. It's not just fewer VC's (which few people decry), but less money to invest for everyone. Darwin on steroids.
But so what? Wasn't there too much money sloshing around already? The vaunted capital "overhang" is naturally correcting itself, right? It's also a fair question to ask: will a shrinking capital base really lead to less
innovation? Won't the scrappiest entrepreneurs still find some way to get financed?
The fact is nobody knows the answers to these questions; we've never had such a dramatic and broad based capital contraction in the post innovation-economy era, where existing funding sources are declining and new ones are dispersed across the globe. In the US it's an age of entrepreneurial uncertainty.
One thing is certain, however: the entrepreneurial sector better get moving or US workers are in for a tough ride. During the first quarter, venture backed companies hired or sought to hire 13,314 people in the US according to the NVCA, a 16% increase from Q4 2009. This represents approximately 5% of all non-government job growth on an average monthly basis in Q1, with higher levels expected in Q2. Historically, the percentage of new job creation by the venture sector has ranged from 5% up to 15%. With 8 million jobs to replace in order to return to historical unemployment levels, somebody better raise some money, start innovating and increase hiring soon or it will easily take another five years or more before we reach historical employment levels.
And where will entrepreneurs get the fuel to accelerate this growth? The truth is I don't know of a single
rational institutional investor who is confidently looking to deploy capital in this environment. I know plenty of investors staring at the end of their investment periods and facing the prospect of returning commitments to limited partners. Which means managing less money and earning smaller fee income. This "use it or lose it" scenario is driving fiercely aggressive deal tactics and outright irrationality when investors find a reasonable opportunity at an acceptable price. Indeed, this is such a rarity nowadays, that entrepreneurs have figured out the game and are wisely auctioning any good opportunity, driving up prices, and setting the stage for even lower returns down the road.
Despite these factors, there remains tremendous pent up demand to start investing again. For entrepreneurs and the investors who support them, the natural state is to run rather than rest, but the wisest stance for now s to crouch. We can stay crouched for a while, but eventually our knees ache and start to cramp. When things turn around, will we have the energy to dash again?