This time, a protective tech bubble???

Many in the VC community, certainly in Israel, seem to be operating nowadays in something of an assumed protective bubble from the troubles on Wall Street and the overall economy. VC firms in the US raised more than $34 billion in 2007 for their new funds – the most since 2001 – and will likely be pouring that money into startups over the next few years. A similar story in Israel – new funds have been recently raised by Carmel Ventures, Plenus, Gemini, Pitango, Evergreen and others (by our count more than $1.6 billion in the last year), and several more (including Genesis Partners, two new cleantech funds……) are planning on raising as well. And the money keeps on flowing to startups, with Q1-2008 humming along nicely with nearly $400 million in VC investments in Israel (see www.leapcap.com/IsraelTechVCReview.html), slightly above 2007’s average quarterly activity.

This is all happening in an environment where economists are debating whether or not we are in a recession or just heading toward one; supposedly blue-chip Wall Street firms are writing off huge sums and raising emergency funds (or selling themselves or their assets for pennies on the dollar) to stave off bankruptcy; and the public new issues (IPO) market for VC-backed companies has all but shut down for the foreseeable future.

In the “real world”, there is some real belt tightening going on. Some of high tech’s largest customer groups – financials, communications companies, global tech giants to name a few – are seeing shrinking revenues and margins and are acting as one might expect them to react: by cutting personnel, cutting costs, and becoming more conservative in all kinds of decision making. This is not a good environment to be selling “stuff” to these kinds of companies – certainly not for smaller tech companies.

Perhaps we should be encouraged that VCs are indeed taking a long-term view and planning for the long haul, by continuing to invest now for exits down the road once conditions in the economy and capital markets presumably improve. That is certainly true for early stage investing. But for companies doing later stage and “pre-IPO” rounds, there will be a lot of pressure to perform (and to keep climbing burn rates in check) in a very tough business market while chasing exits that may or may not develop in the foreseeable future. Israel tech’s pace of a company-sold-per-week during Q1-2008 was quite spectacular, but without an IPO alternative most companies ready to exit will not have much leverage in negotiating with potential acquirers.

The point? – companies (and VCs) will have to keep a very close eye on preserving cash, diversifying funding sources and moderating burn rate at a time when the business and exit environments remain uncertain. We don’t live in a bubble protecting us from the troubles of the economy as a whole. And acting otherwise could have dire consequences.