Friday, May 15, 2009

Future VC Crisis

I usually don't pretend to predict the future outcome of industry. I'm often very wrong about the future like many people out there, but what the heck! There will be a VC crisis... at least in the small segment of those affected by the current trends and from pure perspective of financials .

It is no secret that the cost of startup decreased dramatically. Paul Graham agrees here, and Prof (via NY Times) has an article here to reinforce the case in point. Wait, didn't I argue for rise of startup cost in the past? Not so fast here. Here's the difference:
  • The cost of starting up a company (e.g. ideation, prototype, incorporation, deployments) definitely decreased dramtically. To that point, NYT has a good argument for why that is so here.
  • What I meant to say in my previous blog post was the cost of total capital requirements to create the value at the time of exit went through the roof.
Let me come back to the first bullet about the cost of starting up a company. It is no accident that I talk to quite a few venture investors and entrepreneurs for a number of reasons. We quite often chat about the recession and the impact of economic crisis on deal flow, investments, etc. The investors love the current times, because
  • revisiting valuation in this recession gives them a good leverage to make attractive investments
  • they are busier than ever looking at all kinds of companies
  • cloud computing and virtualization (in the software sector) turned out to present attractive value propositions to customers looking to reduce cost and survive the economy. ehhhh?
The VC Crisis
Without further due, here's my prediction about VC crisis. There will be winners in cloud computing. At the same time, it will be cheaper than ever for web entrepreneurs to start up a business, thanks to the innovation created by the cloud computing companies (invested by VCs). That, in turn, will make it difficult for many early-stage VCs to convince web companies to take money at an early stage. Then, early-stage VCs move downstream to later stage investment where the economics of exit multiples, etc. just doesn't work out well for almost all web investments. Instead of $10M in, $100M out economics, it will be more like $40M in $400M out. By the way, the number of companies that can justify the new economics...... there are even fewer companies to realize that kind of exit, thus more losers.

Summary (I could've Twittered this)
After investing in the sugardaddy cloud/virtualization companies, these companies drive down the cost for other startups, then the startups don't take early-stage money, then there goes the VC crisis. Sounds like now is a suicidal time for VCs.
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