Venture Funding in 2009 — Glass half full or half empty?

January 20, 2009 at 11:07 am

The financial markets melt-down will have long range ripple effects on the Silicon Valley ecosystem, and The Brenner Group’s Gunther Hofmann, Vice President Financial Advisory Services, weighs in with his take on national and local implications.

The National Venture Capital Association recently issued its 2009 Venture Capital Prediction Survey Results (PDF): 92% of VCs predict venture investment to slow in 2009 — down from an expected $30 billion in VC investments in 2008. However, over half of the VCs intend to invest in the same or more companies, leading to smaller deal sizes and likely lower valuations. Clean technology and life sciences are still predicted to have the highest potential for growth.

In the same vein, the Silicon Valley Venture Capitalist Confidence Index hits 2.89 on a 5 point scale (with 5 indicating high confidence and 1 indicating low confidence); the lowest level since inception in 2004. This is of course a steep decline from 4.38 — the value in Q1 2007, but still a far cry from the lowest possible value. Whereas some of the venture capitalists anticipate a “freezing” of funding activity until the economy stabilizes, others expect that this might be a good time to launch a new venture — pointing to lower capital needs of seed stage firms and the longer time horizon of the venture industry.

Widely reported, Sequoia Capital expects the downturn to be prolonged, and advises their portfolio companies to get to cash-flow positive as soon as possible, by all means.

All told, the current downturn surely is worse for the general economy than previous recessions. Venture capital investments will be hit by a number of developments:

  • (Obviously): less consumer, enterprise and government spending (pending any industry-specific stimulus)
  • lower investments into venture funds from institutional investors
  • a longer time horizon to liquidity for venture investments
  • lower public company (and M&A) metrics

However, the pedestal from which we’re falling is a mere $30 billion of expected VC investments in 2008. Compare that with $105 billion VC investments in 2000. There may be overinvestment in certain areas, but nothing compared with the “I-buy-your-banner-ad-you-buy-my-banner-ad” business model we saw in ’99. Since 2005, VCs have raised more funds than were invested, leading to a sizable capital overhang.

So while valuations certainly will go down, and we will see more “investor-friendly” terms, there will still be VC investments in 2009 and beyond. However, companies need to be cognizant of the environment they’re in, creative in their investment structuring and aware of the changed perspective of the investor.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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