Venture capitalists have started warning their portfolio companies to watch every dollar since additional capital will be much harder to come by, according to an article in the Boston Business Journal.
In addition, VCs are advising startups to trim overhead and even “mothball” their operations – reducing a company to its core management team and intellectual property – in order to ride out the current capital crunch and recession.
Later stage companies will find it tougher to raise new rounds of capital in today’s economic climate. Although many VCs have capital to invest, they are concerned about the amount of reserves they have set aside for their portfolio companies, and are doubling or tripling their reserves from the typical 10 percent. Venture capitalists are also spreading the word that every startup needs to be cautious and run lean.
Over a 10-year time horizon, venture capital firms returned an average of nearly 33%, compared to a paltry 3.5% for the S&P 500 index. But those returns include 1999 and 2000, the last few really good years for venture capital, according to an article in Business Week. Moving forward, the 1-, 3- and 5-year returns won’t look nearly as good, and when institutional portfolio managers realize the returns barely exceed the S&P 500, they are going to be reluctant to invest in such a risky asset class. Experts predict up to 30% of institutional investors may go elsewhere, trimming the ranks of venture capital firms.
Yet entrepreneurs and the U.S. economy will still need venture capital, and this painful period of adjustment may help strengthen the venture capital industry in the long run. The surviving VC firms will emerge leaner and smarter, with some of them engineering new ways to achieve higher returns, says Tom Crotty, of Battery Ventures in Boston. Others will turn to emerging markets such as India and China for opportunities.
