The Economic Downturn and Venture Capital
Reflecting on this year is an unwise job and fraught with painful memories. We’ve all argued over the bailout for banks, worried about the support given to AIG and agonized over the measures for the ailing automotive industry. While we are trying to recover ‘big industry’ we have lost sight of the role that smaller businesses and in particular entrepreneurial businesses may have in any recovery. As Schumpeter wrote during the great depression “Economic progress, in capitalist society, means turmoil”. Progress will be achieved once we reemerge from the period of ‘creative destruction’ that we have just entered and entrepreneurial firms will play a key role.
In the interests of hope at this time of year and for evidence of a recovery we might look for the green shoots somewhere in the figures for informal (angel) and venture capital investing. The immediate impact of the economic downturn, however, is likely to hit this part of the economy as it does everything else. Venture capitalists are dependent on funds available within wider financial markets and angels, having seen a significant hit on their personal wealth, are likely to become more cautious. There is also an alternative argument, investment in entrepreneurial opportunities, which were once seen as risky propositions, can become more attractive as other markets begin to look less attractive. So what is happening? A recent study by the University of New Hampshire’s Center for Venture Research published towards the end of 2008 shows that in the first two quarters of the year there was a positive level of angel investment activity. In fact there was a slight increase of 4.3% from 2007, total investments for 2008 reached $12.8 billion and these were in 23,100 ventures. The researchers identified that there were fewer businesses than in 2007 but that they received greater amounts of money. Despite this ‘rosy’ picture the researchers found that angel investors were becoming more cautious. They were investing in fewer deals, reducing their risks by involving more co-investors and were shifting money from earlier stage investment to later stages. Like all academic research this is a limited picture and doesn’t include the decline in wealth that angels may have experienced during the collapse of financial markets and the implications this may have for future investment. So ultimately we need to ‘watch this space’ on angel investment, if it declines rapidly then the scope for entrepreneurial businesses to drive an economic recovery may be hindered.
The data on venture capital (VC) investment is equally interesting and it covers up to the 3rd quarter of 2008. Unfortunately, it doesn’t look good. Third quarter fund raising by VCs dropped six percent and they expect it to continue to decline. Firms that seem to continue to prosper in the VC market have been those that have experience and the number of follow-on funds (those managed by existing businesses) has stayed high. The prospects for the future do not look good here. VCs can only invest in new entrepreneurial businesses if they can exit from their existing investments, recycling the cash. The market for exits, however, is very poor and is the lowest level since 1977. In fact in 2008 there were only six venture-backed initial public offerings (IPOs) where firms are listed on a market.
Bad though the picture looks the irony is that angel and VC investment is only a small proportion of all investment in entrepreneurial ventures; much more comes from family and friends. Hope is something we can all influence. So, if you know somebody who has a New Year resolution to start a business, do everything you can to help, it might just save the economy.
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