Thursday, October 9, 2008

Effects on Economic Downturn on Startup Funding

A lot of my friends ask me what I think will be the effects of economic downturn on Startup funding. There will undoubtedly be some leakage anytime credit gets tight. On the positive side, however, the top VCs will still raise a lot of funds from astute investors running to alternative (long term) investments.

But M&A will be effected in the short term. The crash in the stock market means great companies won't do stock swap for acquisitions with their under valued stocks. Cash rich companies will tread cautiously, and look for bargains given the economic uncertainty.

This means VCs -- particularly the mid and lower tier ones -- will not see exits and liquidity fast enough. As a result they may have to use some of their reserves to hold their portfolio companies over. I.E., less money for new startups.

Private equities, I don't think, are that big of a factor. They will be effected. But most are not into buying mature startups, even though very few of their portfolio companies might.

In terms of sectors, Ad based companies probably will be considered more risky and get even lower valuations.

Publicly held companies are not usually used as comparables, at least not directly. But the market is not cooperating, and lower capitalizations and delayed IPO's means that VC's wonder what their multiples will be.

Assuming the economic effects are not permanent, companies that do make acquisitions in times like this usually make out well. As for investors, average exit is 6 years. So investors that do fund companies are likely do great. Why? from lower competition for their startups, better available work force with all lay offs, to built up from delayed demand. The assumption again is that all things will be equal and there will be a strong recovery. In the meanwhile, emotions and constraints take over.

All the best,
Esfandiar