The "R" Word Surfaces: Recession in the Startup Community?
We have jumped headlong into 2008, and already the economists, pundits and media are throwing around the “R” word. Many retailers had disappointing results for the holidays, a significant interest rate cut is being mentioned, and American Express saw a decline in purchasing by consumers. Are we in for a recession? And if so, what is the startup market looking like if things weaken in the broader economy?
First and foremost, we are not currently in a recession. I have heard or read more than one news report stating that “we might already be in a recession.” A recession is generally defined as at least two consecutive quarters of a decline in GDP. While this definition is not universal, a real decline in GDP is necessary before most notable economists will declare a recession has occurred. The U.S. GDP growth has slowed, but we have had zero quarters of negative GDP since 2001and are not projecting negative GDP numbers in the immediate future.
No one knows with certainty what will happen with the economy, but there certainly are some risk factors surfacing. So let’s consider how the startup market looks outside of the broader market.
Venture firms have been raising and investing money at solid rates for the past 2-3 years. The NVCA is projecting that venture investment levels for 2008 will be in the $27 billion range, which is on par with 2007. Venture firms have also been raising money at a steady pace with $34.7 billion raised for investment in 2007.
Fundraising by Venture Funds, 2002-2007* Venture Capital Year/Quarter Number of Funds Venture Capital ($M) 2002 179 3,936.9 2003 152 10,606.1 2004 208 19,057.6 2005 228 28,282.6 2006 229 31,698.1 2007 235 34,675.9 4Q'05 83 9,276.2 1Q'06 75 6,544.5 2Q'06 77 14,185.5 3Q'06 67 5,375.3 4Q'06 65 5,592.8 1Q'07 80 5,754.2 2Q'07 85 9,141.8 3Q'07 77 8,763.7 4Q'07 63 11,016.2 Source: Thomson Financial & National Venture Capital Association *These figures take into account the subtractive effect of downsized funds
So what does all of this mean for the venture-backed job market? One might surmise that from the level of fund raising and investing within the industry that job creation should be very high. But we also had record fund raising and investing within the industry before the bubble eventually burst in the dawn of the Internet era. It can be difficult to predict how the investing and fund raising trends will impact overall job creation in the venture-backed economy.
Beginning in 2004, I became more optimistic about job creation in the venture-backed startup community. Firms raised $19 billion in funds compared to only $3.9 billion in 2002. Venture capital firms generally have funds with a life span of 7-10 years. The terms of those funds generally require them to invest money into companies over that life span rather than keep it on the sidelines in interest bearing accounts. I could tell from the money raised in 2004 that by 2006 we would start seeing a lot more money plowed into the startup community, which meant more job creation. VentureLoop benefited greatly from this trend, as we more than doubled the number of venture capital clients we work with from the middle of 2006 through the end of 2007.
As you can see from the previous chart, fund raising in the VC community has been quite healthy for the past several quarters. Strong liquidity in the market has brought investment dollars back into the startup community, as the prospect of getting real returns on investment has blossomed. As the stock market wanes, these liquidity options will also diminish. That should then create a trend of less money raised by venture firms, slowed investment, and even returning capital to limited partners by some firms who would rather not invest than invest in companies that will not give them the returns they want.
Another trend I like to follow is the actual percentage of new investment dollars allocated to seed stage companies and the percentage of first round investing allocated to seed stage. Using figures from the MoneyTree Report distributed by PricewaterhouseCoopers, one can analyze not just how much money is being invested but also in what stages it is being invested. The reason I like to follow this trend is that the percentages help tell how much venture money is going into brand new ventures to create new jobs and how much might be going into later stage investments to sustain an existing company before it reaches stability. During the Internet era decline, you may have noticed a lot fewer Series A investments announced and far more Series C, D, and E investments. While money was still being invested, it was often to sustain existing companies rather than build new ones that require hiring an entire team.
From the figures noted, the money invested in Seed Stage companies for 2007 is still healthy but could be declining. It will be interesting to see the full numbers for 2007 once they are released. My overall assessment for 2008 is that the startup job market will continue to grow at a good pace, but potentially not quite as strong as 2007. If the broader economy does not fair well through 2008, then we could see further trending away from the earlier stages of investing by the venture capital community into sustaining existing companies with lower risk. That in turn may impact overall job growth in the sector, but I do not see a near-term contraction in the startup job market. There is too much money that needs to be invested that was raised in the past three years, and the exit opportunities for venture firms (liquidity) would have to suffer for a few quarters before we will see an impact on hiring.