Silicon Valley VC confidence index falls to new low

Mark Cannice — Wed, 09 Jul 2008 07:57:20 -0700

I have surveyed Silicon Valley venture capitalists every quarter since Q1 2004, asking about their confidence in the future high-growth entrepreneurial environment in the Bay Area. On average, between 25 and 30 venture capitalists respond to each survey and give a quantitative measure of their confidence on a five-point scale (1 = low, 5 = high) along with commentary that describe their ratings. While historical data on venture investment, funding commitments, and other industry metrics are readily available from other sources, I use this survey to ascertain venture investors' sentiment about the future, as it is the future which entrepreneurs and technologists care about when they seek new financing to build their companies.

It will come as no surprise to Industry Standard readers that VC confidence declined in Q2. Based on a survey I completed between June 26th and July 3rd of 27 Silicon Valley VCs, the Q2 index registered 3.07 on a 5 point scale. That is down from 3.22 in Q1 -- the previous low point in the history of the survey, and 3.54 in Q4 2007 -- the low mark before that (please see the inset graph for trend data.)

How telling is this measure of VC confidence in the future entrepreneurial environment? The previous low points in VC confidence in Q4 2007 and Q1 2008 preceded the dramatic slowdown and halt to venture-backed IPOs in Q1 2008 and Q2 2008, respectively. Bear in mind that the VC confidence Index declined sharply in Q4 2007 despite the fact that 2007 was a very good year for VC firms. Therefore, the insight of the responding venture capitalists appears to be well tuned to the near-term functioning of the public capital markets with respect to venture-backed liquidity events.

But how problematic is this current venture environment? In a recent press release regarding the drought of IPOs of venture-backed firms, the National Venture Capital Association stated "the situation is concerning enough to be characterized as a capital markets crisis for the start-up community." The Silicon Valley venture capitalists who responded to these quarterly surveys appeared to have a good sense of this impending decline of IPO activity. Upon reflection this foresight seems reasonable given that VCs provide active guidance to their portfolio firms and work closely with investment bankers and potential corporate acquirers in negotiating potential exit strategies.

So why did VC confidence continue to decline in Q2? The deteriorating economic landscape was the most oft-cited reason for a more difficult venture environment and lower confidence. Shomit Ghose of Onset Ventures pointed to the decelerating economy, which he noted is negatively impacting the public equity markets and potential liquidity events for venture-backed firms. Steve Carnevale of Point Cypress Ventures delivered a grim prognosis, stating that "we are headed for a major economic problem worldwide . . . This will impact revenue generation of portfolio companies, as well as exit strategies and funding sources." Clearly, the macro economic malaise is impacting the business model of the VC portfolio firms as well as the ability of VCs to take these firms to profitable liquidity events.

The confluence of poor current economic conditions and lower VC confidence in the future portends a difficult financing challenge for entrepreneurs in the near term. This doesn't mean funds aren't available. Debra Beresini of invencor said many venture firms actually have money to invest in startups. Most, however, "are holding onto cash," she said.

So should entrepreneurs give up hope on attracting venture capital now? Not necessarily. Some responding VCs argued that hard economic times are a great time to build a stronger, leaner company. Dag Syrrist of Vision Capital offered, "in hard times we generally make better investments, companies make better decisions, cash lasts longer and great companies are formed." Sometimes it pays to swim against the tide.

So will VC confidence rise or fall in Q3? I encourage Industry Standard readers to reflect on the expert insight of the venture capitalists I directly quoted in my Industry Standard essays and quarterly reports, and offer their own analysis here.

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