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Recession Won't Dry Up VC Funding

Don't worry too much, all you would-be entrepreneurs. If the shaky U.S. economy slips into recession, venture capitalists will certainly rein in their investments—especially in Web 2.0 and green technology—but aren't expected to pull up as hard as they did when the dotcom bubble burst, say industry observers.

Green or clean tech could be the first area to experience decreases in investment since environmental causes take a backseat during a recession, says Mark Hessen, president of the National Venture Capital Association, a trade organization. "Things like clean tech are nice to have but they're not required," he says. "If times get tough, it might be on the chopping block more."

Hessen adds that Web 2.0 startups could also see funding declines. "They get affected in that most of those [Web 2.0] companies have a specific agenda, which is to get acquired by companies like Google, Yahoo (YHOO) and eBay. (EBAY)"

Assuming Google or companies like it continue to invest robustly and acquire companies at a rapid pace, small or midsize firms will have less to spend on startup acquisitions, says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. That will slow the market for such deals, as those companies would be more affected by a tanking economy. "Those companies are going to be affected a lot if we go into recession," he says. "For many investors, that exit [strategy] could dry up."

On the surface, venture capital fund-raising hasn't been this exuberant since the dotcom bubble. According to a report by NVCA and Thomson Financial, VCs raised $34.7 billion in funds in 2007. They haven't raised that much since 2001, when they brought in $38.8 billion. If a recession hits, however, it's not clear how that will affect the acquisition strategies of large technology vendors, which tend to formulate long-term plans for purchasing startups or other competitors, says Alex Cullen, VP and research director of Forrester Research (FORR). "A firm like an IBM (IBM), Google or Microsoft (MSFT) doesn't base its acquisition budget on near-term economic forecasts," he says. "They'd drive themselves crazy if they did."

The issue of venture capital hits home in the technology field, where investors were hurt by the dotcom bust. But Hessen says investors learned their lesson. "Last time you had a Wild West mentality," Hessen says. "You had entrepreneurs assuming they'd be millionaires." VCs now demand that the companies in which they invest show viable business models and ability to generate revenue, says Sohl. "In Web 1.0, you didn't even need to do that," he says. "Today, they have to show they have a real company and real customers. They need to show they can make money over time."

-C.G. Lynch

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