What will the fall of 2011 look like for entrepreneurs?
It is that time of the year again — the dog days of August when I wax poetic about the prospects for start-up companies in the coming months.
This post is a follow-on to my Summer time or is business slowing post about a year ago. At that point, things seemed slow, the economy was uncertain, but sentiment was that things would pick up for entrepreneurs. In fact, from last July to this one, things looked promising for those of us who bring new products and innovation to the marketplace.
Valuations were soaring, IPOs were picking up steam and Boston was back on the map. In March, I claimed that perhaps valuations were getting too high or bubblicious. In the middle of June, I left TechStars Demo Days feeling like the entrepreneurial scene in Boston was thriving and partying like it was 1999. TechStars had 12 companies present to hooting and hollering, a rollicking after party with Coolio, oversubscribed rounds – the whole scene to me reminiscent of the web 1.0 days late in 1999/early 2000.
When I first started thinking about writing this post, I was going to talk about how well Boston's start-up scene was doing despite the occasional whining about what’s the matter with Boston's negative energy. Powerful, external events intervened.
The Dow is down 8% as of Aug 15th and was down as much as 20% in the last few days. The market has been up and down over 4% in a day for many days in the last two weeks. The market is volatile which scares angels.
What does the volatility in the public markets mean for start-ups?
To get some insight, I reached out to several early stage investors and micro VCs. Most of them are on vacation (where I am headed myself until early September). Fortunately, the prolific Angel investor, extraordinarily nice guy and always communicative Ty Danco set me straight this weekend. These are some of our conclusions:
1) The investment environment for start-ups changed on Aug 8, 2011
- The Dow lost 635 points or 5.6 %. Angel investors take a percentage of their assets, typically 10% to invest in the private, often illiquid market of start-ups. This 10% is usually their "fun" money. If they lose it, no big deal. When the rest of their portfolio is down 20%, as it was just last week, this has a non linear relationship on their angel investments. A 20% drop in net worth, can translate into a 100% drop in angel investing.
- Angel investments might just stop for now, but more likely will slow at a rate much greater than the stock market drop. Investing in early stage companies with public markets unstable is not a risk many angel investors want to take.
2) $25K is the new $50k
- Ty Danco paraphrased a prominent local investor about the new $50k. The Angel community is small and tends to move in herds.
- Angel investors, once comfortable dropping $50K into an unproven venture, will now be thinking $25K. Of course, this is much better than zero dollars. The Angel community will not stop investing, but overall raises will be smaller and may take more participants to meet your fundraising goals.
3) Deals will get done, but will take longer
- When I was the CEO of BPG Motors, we closed our first Angel round at a great valuation in February of 2009.The round was in the middle of a truly historic financial meltdown. Banks stopped lending. Money market funds were paying less than a dollar for a dollar invested . It took us until Feb 2009 to close a round committed in July of 2008. Deals will get done in any markets, but will take longer if the markets continue to be volatile or correction moves back downward.
4) Valuations will recede
- With fear creeping back into the market and investments likely getting smaller, the pendulum has started to swing back to the early stage investors. I don't think we will see more deals like Color's crazy $41M pre revenue investment. Start-ups for the most part will gravitate back down to more average and less bubblicious valuations.
5) Capital efficiency will creep back into the lexicon
- In 2009, capital efficiency was omnipresent. It’s coming back. Then, there were no exits and investors were intrigued by capital- efficient businesses. Can your business succeed with the smallest amount of capital possible? Capital efficient businesses tend to be the double and triple kind of start-ups and not the homeruns. As the confidence in the market fades, we will see the market sentiment swing back to performance over promise.
6) VCs will continue to invest
- Valuations stagnating or falling are great opportunities for VCs to buy low and sell high. The VCs with funds already closed will see lower valuations as an opportunity to invest. VC deals will continue to happen, but perhaps with increased due diligence (slow the deals down).
7) Timing is everything
- To all those great companies that closed your rounds in July, congratulations. You did your deals before the spigot started to close. For all entrepreneurs, the great lessons here begin with time, rarely on your side. No matter how great your business is, you are subject to external market conditions. You always should be running to get your deals done because you really never know what external factors are going to affect your success.
8 ) Sky is not falling
- Valuations were likely getting high before this market correction. Deals were getting done at a crazy fast pace. Valuations will not plummet; deals will continue to get done. Entrepreneurs will continue to thrive. Great companies will continue to be great companies.
- Less great companies may not get funded and good companies may have to work a little harder. Remember: while the markets may have slowed, this fall will be a heck of a lot better than the fall of 2008.
What do you think? As always, I would love to hear what you think the fall with bring for entrepreneurs. Please leave your comments in the disqus section below.