The impact of Bear Stearns' collapse on entrepreneurs

Mark Cannice — Mon, 17 Mar 2008 15:06:55 -0700

The financial highway for high-tech growth companies that often starts in Silicon Valley and San Francisco frequently heads toward Wall Street and its investment banks. The unprecedented and rapid collapse of Bear Stearns, one of Wall Street's venerable investment houses, will have ripple effects throughout the U.S. financial system. The fallout is not likely to leave Silicon Valley and its entrepreneurial ecosystem unscathed.

Silicon Valley venture capital firms finance local high-tech growth ventures with the plan and expectation to eventually take these companies to the public markets – typically through M&A or IPO activity. This sale or exit strategy lets venture firms convert their equity stake in their portfolio companies back into cash. Known as "liquidity events" to venture capital firms, IPOs and M&As are essential to the VC business model. A troubled exit environment for new issues means, at least, temporary challenges for the VC business model. Firms may be less likely to invest in new firms, or be more stringent on their terms. This means a tougher road for hopeful new companies that require significant venture funding.

Several Silicon Valley executives/investors have shared with me their thoughts about the latest Bear Stearns developments. Dave Epstein, a venture partner with Crosslink Capital in San Francisco, says that he sees, "nothing immediately short-term that already isn't evident. The [near] recession has closed the IPO markets and this event serves to confirm the longer-lived nature of the slowdown. Over the next few months, we will see whether this is a one-off event or a bellwether for how many investment banks will fall. In the latter case, this will have a continued cooling effect on later-stage companies. In turn, this will affect the valuations of the earlier-stage investments."

An even more worrisome perspective was provided by Jon Fisher, the former CEO of Bharosa, Inc. which was sold to Oracle last year. Mr. Fisher offered that "the unprecedented collapse of Bear Stearns will contribute to a wave of startup bankruptcies and failed mergers in the next few quarters. . . . I'm especially concerned about the employees and investors represented by Bear Stearns in merger transactions. This is a terrible thing to have happen in the middle of a deal."

It is not immediately clear how many venture-backed firms are in process with Bear Stearns, or how this event will impact their prospects. However, the additional uncertainty created by Bear's rapid decline does not bode well for venture capitalists' confidence. As VC confidence declines, it will be more difficult for entrepreneurs to access needed venture funds.

Steven R. Gerbsman, principal with Gerbsman Partners, commented that "venture capital and private equity should start seeing additional challenges in their portfolio companies." While he believes that VCs still have lots of cash to put to work, he expects that decisions to consolidate portfolio firms and their platforms may be more likely to occur now. Another investment banking expert who asked to remain anonymous believes that the drying up of public financing may lead to lower capital expenditures by new ventures, which would negatively impact the larger enterprises that supply them.

What happens next? Epstein believes that "entrepreneurs must heed this as a warning that more expensive and conservative cash is on its way." It appears that startups' business models and expectations may need to be revised to allow for this new reality. This, in turn, means slower growth and a longer road to Wall Street.

Related news, commentary, and predictions:

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Mark Cannice: Venture Capitalists' Confidence Wanes
Mark Cannice: China VC confidence index sees mild drop
Mark Anderson: Chavez, China, and the coming startup squeeze
Mark Anderson: Fixing the subprime mess: A Modest Proposal
News: VC tech spending saw surge in 2007

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