Is the venture capital glass half-full or half-empty?

The VCs remain bullish:

So why am I so sanguine about the prospects for venture capital as everyone seems to sound the alarm about Recession, the lack of capital, and the fear gripping the markets? It is simple:

1. Venture capital returns are predicated on scarcity of risk capital.  It has been all too abundant. That will change.
2. Many good businesses will be left on the beach as the rest are washed out to sea – the remaining VCs will invest in them and both the entrepreneurs and VCs will get rewarded as the survivors gain market share and become successes in the economic recover.
3. The economic recovery plan of the new Administration will be massive and favor investments in productivity-enhancing growth sectors like information technology and energy technology.

Investments in material sciences electronics will blossom to provide ever-cheaper sources of domestic clean energy, today’s temporarily cheap oil notwithstanding.  (As the world economy recovers, the new capitalists in China and India will buy more cars and build more factories, rapidly returning oil back where it was and beyond.)

Investments in broadband, wireless, and mobile multi-core devices and cloud computing architectures will continue to reduce the cost of providing high value services in healthcare, personal entertainment, and even traditional enterprises.  Cloud-based computing will allow enterprises to treat IT as a variable cost, increasing their willingness to adopt by maintaining flexibility without big upfront expenditures. 

As the fire continues to rage in financial markets, it is hard to imagine when Opportunity will reappear. But the truth is when everyone sees Opportunity; they are only seeing the reflection.  True Opportunity appears at the market bottom, not at the top.   It’s times like these that test what you believe in, and I believe in the Business Cycle, Human Creativity, and the stimulative effect of massive Government spending. 2009 and 2010 will be great times to invest to reap the benefits in 2012-2014, for those who can judge both business risk and liquidity risk, and have the courage of their convictions.

Of course, the outsiders - and historical performance - would disagree:

This year, venture-backed companies generated $24.1 billion through initial public offerings (IPOs) and mergers and acquisitions (M&As), down 58 percent from $57.6 billion in 2007, according to Dow Jones VentureSource.

That drop is particularly worrying when you consider that most of the deals happened before the financial industry’s collapse in September and the resulting stock market plummet, so you can expect early 2009 to be even worse. A better indicator of the months ahead is the fourth quarter alone, when there were no IPOs, and M&As only generated $3.9 billion — the lowest amount in a single quarter since 1999. Meanwhile, the $551 million earned from IPOs during all of 2008 marks a drop of more than 90 percent from 2007, and is the lowest total since VentureSource started tracking this data in 1992.

Venture firms aren’t just making less money, either; they also have to wait longer for their investments to pay off. The median time to exit via M&A was 6.5 years, and the median time to IPO was 8.3 years — both numbers setting new records for length.

So basically, if you look into the rearview mirror, things look bleak.  But looking ahead, things look rosy.  They say it’s darkest just before dawn… so both sides are probably right… but I am not sure it’s darkest just yet.  I expect a lot of VC-backed casualties in 2009.  For more on this, read our 2009 year in preview.

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