Check, Please. A Bad Economy is Good for Venture Capital

I'll let go if you let go.

Let’s hear it for venture capitalists. I love venture capitalists. You know why I love them? Because they are irrepressible optimists. Look at what just happened. While the rest of the country was racked by the largest financial meltdown in 50 years, venture capitalists were giddy with excitement about technology’s ability to improve humanity and make them a nice buck along the way.

It’s easy to get cynical about them when you’re down in the trenches trying to start a company. It’s doubly easy to get cynical about them when you’re out there starting a “consulting” company and they don’t care one iota about investing in you….but I gotta admire them.

2009 was a crap year for a lot of people. My company nearly went out of business. Banks had a black eye from their, shall we say, less than austere lending practices. Since they couldn’t make it up by getting paid back from their bad loans, they called in a bunch of good loans early. Nearly every small businessman I knew in 2009 had their line of credit called in by the too big to fail banks. Lending had all but stopped. Yes, I’m still bitter about it.

But venture capitalists? Steady as she goes. Sure, in 2009 they ONLY invested around $20 billion dollars in over 3000 firms. But still. God bless ’em. And sure, after the crash of 2001, they pulled way back, but a look at this chart tells you pretty clearly that by and large, come boom or bust, venture capital still flows.

So this raises some interesting questions for me. In 2000 and 2001, the internet WAS the boom and it WAS the economy. When it crashed, the economy crashed. But the 2009 bust had nothing to do with the internet. Looking at investment levels, we can see that just before the 2009 bust venture capital was getting a little frothy again – reaching comparable levels to the last quarters of 1999, also known as “the beginning of the end.” The internet avoided a bubble and didn’t tank the economy, the bankers did it for them.

So what happens now? I’ll take a cue from the venture capitalists and risk being a smidge optimistic here: the economy one of these days HAS to rebound. If the VCs are plowing some $30 billion a year into startups now, what are they gonna do when the economy comes back? Even in these down times, thanks to our ridiculous wealth distributions, we are already seeing dumb money from hedgies flush with cash follow the smart VC money. This is gonna get ridiculous when the economy rebounds.

I know, I know. It’s mainly rich people in VC right now. It’s not gonna hurt the layperson. This was the argument only a year ago when the tech investment market got frothy. But even now in this still-sagging economy we’ve witnessed the impressive IPO of LinkedIn and the less-than-perfect-yet-still-successful IPO of Groupon. Can you hold your head high, after these two IPOs, and still say that it’s only a bunch of rich dudes?

The saving grace is that the money going INTO VC funds has stayed pretty low and is on the decline. This is probably good. It seems to be keeping things cooled down to some extant. However, the main reason cited is the general lack of good exits. Perhaps the LinkedIn and Groupon IPOs weren’t enough to assuage their concerns – we’ll have to see in next quarter’s data – but as the economy in general rebounds, and more companies successfully go public, will this hold? If the much-anticipated Facebook IPO is anything like the Google IPO, we could have a full fledged boom on our hands. And let’s not forget that the money going into venture capital funds often comes from. In 2009 18% of venture capital came from public pension funds. So maybe it’s not only rich people. Just 82% rich people.

I’ve called this glorious tech era we live in now the beginnings of a bubble before. The larger economy as a whole has held it in check but what happens when that check is gone? Will that unbridled enthusiasm I love so much in VCs take us down that trail again? We all kind of held our heads in shame hanging around at family reunions after 2001 when we tanked the economy, right? How awful would we feel if we tanked it again right as things were starting to heat up? I’m not wishing a bad economy on anyone, but it does introduce a healthy dose of caution to these eternal optimists. Check, Please. A Bad Economy is Good for Venture Capital