March 21, 2006

This Can’t Be Happening: The Econony Stinks!

Filed under: Business Moves,Economy,MSM Biz/Other Ignorance — Tom @ 9:07 am

WELCOME INSTAPUNDIT READERS! Thanks to Glenn for the link, and intense apologies to all for the slow server response (I think the problem ended at about 4PM ET). I’ve cut the number of posts per page to two until the Instalanche plays out. Believe me, something will be done about this in the next couple of weeks.
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Venture Capital Money Is Flowing Like Water…. In Silicon Valley, and Entrepreneurs Aren’t Even Asking for It!

It will be interesting to see whether news of this outpouring of venture money, which as you will see is truly remarkable, gets out of the financial pages in The So-Called Mainstream Media.

Remember the gloom and doom several years ago as punditeers said that Silicon Valley would never be the same again?

Somebody forgot to tell the investing community.

A free article in yesterday’s Wall Street Journal says that unsolicited venture dollars are flowing into Silicon Valley start-ups — Even if you’ve known that the economy is in pretty good shape, you’ll be shaking your head in near-disbelief as you read this:

Silicon Valley Start-Ups See Cash Everywhere
Through ‘Pre-Emptive Financing,’ Venture Capitalists Shower Firms With Cash, Stake an Early Claim

The market for high-technology start-up businesses is so intense in Silicon Valley that some companies are being showered with millions of dollars from investors — without even asking for it.

It is a phenomenon called “pre-emptive financing,” and it has become more common in the past several months.

The question is whether venture capitalists are moving too quickly, funding risky, untested start-up businesses — just as they did during the heady, and ultimately unsustainable, technology-stock boom of 1999 and 2000.

Pre-emptive financing happens when a venture capitalist seeks out a promising start-up business and offers it money out of the blue, before the company tries to raise a second or third round of cash. If the offer is good enough, in theory, the venture investor will snag a piece of the company quickly, thus avoiding a costly bidding war that could erupt later once the company says publicly it is looking for cash and attracts several suitors.

Such bidding wars are increasingly common these days and have pushed up prices investors pay for stakes in some start-up companies. The median valuation of venture-funded start-up businesses — the amount investors think these companies are worth — soared to $15.2 million in 2005, from $10 million two years earlier, according to research firm VentureOne, a unit of Dow Jones & Co., which publishes The Wall Street Journal. Venture capitalists typically take stakes in small, private-sector companies, hoping for a payout later through a company sale or an initial public offering of stock.

The trend puts many start-up companies in the driver’s seat. “I’ve had several [venture-capital] firms come to me long before we were looking for money,” says Jason Goldberg, chief executive officer of Seattle online job-search concern Jobster Inc. His company, after getting unsolicited calls from two venture firms last year, raised $19.5 million in additional financing much earlier than it had planned. Young companies in wireless communications, computer games and consumer Internet services are big targets for pre-emptive funding calls these days.

It all highlights how desperate some venture capitalists have become to find homes for the huge amounts of cash they have raised, and how few companies there are that really deserve their money. Last year, venture-capital firms raised $25.2 billion from investors, the most since 2001, and they are struggling to put all that money to work.

….. Some investors are so eager to one up each other that they don’t even bother to find out who to call at promising start-ups. A Pasadena, Calif., home-improvement Web site, Done Right, operated by a company called Perform Local Inc., received an email in January from a well-known investment firm inquiring about putting cash into the company. Paul Ryan, Done Right’s chief executive officer, says the missive wasn’t sent to him or to his executives — it landed in a general corporate email inbox. Mr. Ryan wasn’t put off by the impersonal plea: “We’re having very good discussions with [the firm] right now,” he says, declining to name the potential investor.

The one part of the article that I believe is all wrong is the analogy to the dot-com bubble that burst in 1999 and 2000. This is totally different, and the author should have known better. Venture capital (VC) money, which is all that is discussed in the article, is meant to fund start-ups and early stage companies. If the VC folks lose their shirts, well, it’s part of the high-risk game they play.

No, the problem with the dot-com bubble was that so many of these companies went public while they were still in their start-up and early stages. The stock-investing public got duped (and, yes, lured in by naked greed) into taking on levels of risk not normally associated with owning listed stocks. The normal rules of thumb, things like having a track record of sustained and well-above-average sales and earnings growth for at least three years (preferably five), got totally thrown out the window. Heck, some of the dot-com public start-ups barely had generated any revenue at the time they went public. Truth be told, I believe that the many of the VCs knew darn well that they were dumping dogs on the public as they took their money and ran. But, the investing public was dumb enough to buy in.

So, we’re not heading back to the irrationally exuberant stage — yet. When the VCs are the ones taking the early-stage risks, that’s the way it’s supposed to be. Let’s hope that the memories of NASDAQ 5000 falling to NASDAQ 1200, and the 99% haircuts many dot-com stock prices took (even the companies that survived), are still fresh enough in the public’s mind that these companies have to actually prove themselves before getting into the public-equity market.

In the meantime, I’m thinking about renting space out in a San Jose office building and putting in a phone with a forwarding number just to see if I can get the VCs to call. Don’t tell them I’m from Ohio.
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ADDENDUM: Let’s not hold back here — One of the reasons the Silicon Valley revival has as much steam as it does is the reduction in federal taxes on capital gains that were part of the Bush tax cuts in 2003.
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Cross-posted at NewsBusters.org.
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UPDATE: S.O.B. Alliance member Large Bill points to an OpinionJournal.com piece from Sunday in which House Democrat Minority Leader Nancy Pelosi of California, who represents part of the Bay Area, talks of reducing some of the worst excesses of Sarbanes Oxley. Although her language is vague, this is no accident; when the VCs in the general area she serves want to cash out and have their companies go public, it will be less ruinously (and in my opinion, pointlessly) costly to do so, and better for the overall economy of that region. It would be nice if she would extend the logic of reducing burdensome taxes and regulations to other areas, but we shouldn’t hope for too much.

UPDATE 2: Kevin at Pundit Review rounds things out with a lot of other good information about a dramatic increase in Hispanic-owned businesses, loans to minority-owned enterprises by the Small Business Administration (I’m not a fan of SBA, which is a topic for another time, but this increased lending activity is an indicator that entrepreneurship is ethnically diverse), minority home ownership, and increases in real disposable income. The point: The prosperity is not happening for just few nerds in the Bay Area who happen to be in the right place at the right time, it’s occurring virtually across-the-board. It would be nice if the Democrat/liberal portion of the population, and their Mainstream Media spokespeople, recognized it.

UPDATE 3, March 24: Better late than never — On Wednesday, Spacetropic came across an article that says “industry is underserved by experienced technologists.” I have some anecdotal evidence that would support that.

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6 Comments

  1. How do I get some of that to expand my blog?

    Comment by David Pinto — March 21, 2006 @ 3:56 pm

  2. I think the secret is to rent a cubbyhole in San Jose, get a phone number and an e-mail addy, and see what happens.

    Comment by TBlumer — March 21, 2006 @ 4:11 pm

  3. The big bust in 1999 and 2000 came from companies short-cutting the last (and later, the second-to-last) rounds of VC funding and going straight to IPO. This allowed the founders to retain double-digit ownership percentages of their companies that paid off very, very well. The problem, as you pointed out, is that this strategy pushed the risk familiar to VC investors onto much less sophisticated investors.

    This current round of start-up seem to be much more canny about cash flow. I don’t see a lot of all-day Friday Barbeques and the nerf-gun fights are restricted to after-business hours. I am in this market (I work in the technology sector) and I am expecting some good times.

    Comment by Beryl Gray — March 21, 2006 @ 5:47 pm

  4. #3, good to hear. Let’s rock n roll.

    Comment by TBlumer — March 21, 2006 @ 6:11 pm

  5. The economy is obviously in the pits.

    Pay raises for tenured academics are well below the rate of inflation and no improvement in sight.

    Meanwhile, ‘quality’ newspapers all around the US are sinking forther into crisis as their circulation drops. Reporters have had to be fired – even editors.

    It’s obvious, the economy sucks!

    Comment by Don S — March 22, 2006 @ 5:08 pm

  6. Yes…..the economy is in the dumpers for the little guy!!!

    Comment by Savings Bonds — March 29, 2006 @ 10:41 am

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