Think long term. Long, long term.
In the short term, there will be pain in Silicon Valley. Start-ups will have to survive 2009. Layoffs will be in fashion: "You didn't do a layoff? What's wrong with you?"
Venture capitalists will be hit just as hard. Their investors--the endowments, the pension funds
and others--are hurting. The entire portfolio of the California Public
Employees Retirement Fund, for example, a major investor in venture
funds, is down 20% and needs to raise capital. Cash will be scarce in
2009, no matter if you're a pension fund, a VC or a start-up. Wall
Street is broken.
But Wall Street has been broken for eight years now, as far as
Silicon Valley is concerned. Alan Patricof, a legendary venture
capitalist, recently remarked: "We no longer invest with the idea of taking our companies public. If they do [IPO], it's an accident."
He's right: These days, IPOs are an accident. Since 2002, there have
been just 351 IPOs out of 19,300 VC-backed companies--fewer than one in
50. If the notion of an IPO seems so 1990s, well, it is. Just two years
in the late 1990s, namely 1996 and 1997, saw more IPOs than the last
eight years (2001 to 2008) combined. The ratio of mergers and
acquisitions to IPOs has gone from roughly 1:1 from 1996 to 2000 to 6:1
during 2001 through 2008. The National Venture Capital Association has all the grim statistics.
Given this lack of IPOs, VC returns have plummeted and the average
VC is likely to lose money. But the impact is much bigger than the VC
business.
Wall Street has been unwilling to risk investing in relatively
small, rapidly growing, unprofitable technology companies. A $100
million high-growth revenue company is no longer an interesting
candidate for an IPO. Being acquired is the only logical endpoint. Thus
the $100 million company that could have potentially become a $1
billion company with some nurturing and capital instead becomes a piece
of some large company. With its fate no longer in its hands, the
company loses its key management and its vision, and in most cases, is
eventually forgotten.
For example, a company like Amazon.com
(nasdaq:
AMZN -
news
-
people
),
which went public in 1997, could never have had an IPO in this
environment. Instead it would have become a part of Walmart and likely
would have been shut down during the tech bust. In today's market, you
need to be a Google
(nasdaq:
GOOG -
news
-
people
) to make an IPO. For most companies, that's just too high a bar.
The sad truth is that we are replacing potentially great companies
with underperforming divisions of mature companies. Acquisitions
invariably remove both the future risk and rewards--not just for the
company but for society as a whole. Innovation is stifled, and that
hurts us all.
Why did this happen? This is the controversial part. In my view,
some of it was a reaction to the technology bubble we had in 2000. Once
burned, twice shy. But more important, Wall Street discovered a way to
make easy money. With massive leverage and seemingly with no risk,
investment bankers acted like they could print money. Instruments,
abbreviations and money were created like there was no tomorrow: CDOs,
CDSs, SIVs ... Why bother wasting time and money investing in a
technology company?
As we have discovered, there was huge risk in all those
abbreviations. We, as taxpayers, will pay for it. Thankfully, at least
this business model is finished.
Once Wall Street gets over protecting its money, banks can return to
the business of making money. But here is a fundamental truth: to make
money now, you will have to embrace growth and risk.
The $100 million technology company will become an attractive
investment again. Both Silicon Valley and Wall Street will once again
bet on creating the next Amazon.com. And in my opinion, the bar for an
IPO will go down over the next few years, once again creating a vibrant
ecosystem in Silicon Valley.
Economist and former Chairman of the Federal Reserve Paul Volcker
has said that the so-called "financial innovations" of the last few
years largely rearranged existing resources instead of making real
contributions to the economy. As a society we want financial returns to
be aligned with value creation. This crisis will jar the the two back
into alignment. Value creation is hard. But no one does it better than
Silicon Valley.
So take the liquidity and capital that the Fed has pumped in, throw
in a disruptive technology--and get ready for the Great Tech Bubble of
2012. We live in a world of bubbles, don't we?
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