In my previous post, I skipped a step and made some guesses about how a slowdown in venture funding could ripple through the industry. Is such a slowdown likely? I would argue that it is inevitable, all industries ebb and flow. These tides of fortune are driven by capital flows more than anything else. And right now, capital is very cheap for a large number of Internet, software and other tech companies.
Capital is cheap because of global macro-economic conditions. There is a ‘savings glut’ that is so pervasive it has its own Wikipedia entry (and here is a good page of Google search results on the issue). Lots of people (or countries) have big piles of cash and are having a hard time finding returns on that money. When stock funds generate 3% returns, investors look to riskier assets – art, luxury real estate, private equity, venture capital, etc.
Someday, this will change. I have no idea when, but I think it is reasonable to suspect that whenever interest rates start to go up in the US, it will spark follow-on changes throughout the economy. It will not happen overnight, but eventually interest rates will get high enough on bonds and bank deposits, that investors will start to park money there rather than risk losses in more exotic assets.
I used to hear all kinds of arguments about how this will not affect the Valley and the tech industry – lean start-ups, capital efficiency, this time is different, etc. But lately, I think most people would agree that current conditions can not continue forever.
Instead, I think it is more productive to think of what leading indicators we can expect. I would not argue that anyone should pull back on venture investing now. This is still a great time for many companies to grow. There are a lot of very powerful, productive forces getting unleashed. Invest in them, grow them. But it would also be nice to have a bit of a heads up that the good times are going to take a pause. Some of these could include:
- The closing of the IPO window. It is wide open now, but that will not last forever. This may come after a sharp ‘correction’ of the broad stock market. These things are not always directly related. You can have IPOs in bad markets, and no IPOs in good markets, but there is some correlation.
- More than one venture shop failing to raise as much money as expected.
- Craziness in the bond market. This is actually the one I would track most closely. The other two are pretty obvious, but no one in tech watches bonds. And this is probably the best fortune teller out there. A falling bond market, means interest rate expectations are going up everywhere. And that will make venture investing relatively less attractive.
The key to all of this is to not expect dramatic revelations. The drama only comes once things are obvious. In the past, I have tried and failed to predict when a slowdown will occur. I really have no idea when it will happen. But I think it is worth preparing for such a day.