The Best of Bad Times
Could the recent meltdown of the subprime lending market be good for tech? Let me argue a domino effect: subprime markets crater, which precipitates a pull-back on banks financing mid-tier debt for private equity, which means lower returns. The allocation of money to private equity slows, but there is a wave of money that must get invested. Venture funds find that they are again in vogue, even though their returns over the next five years will be lower than they were from 1995 to 2000.
Just as the meltdown in 2001 creamed funds started in 2000, the ongoing meltdown in credit markets may restore balance. Both silly high returns and low returns hurt high-tech. Silly high returns do so because there is a backlash (which always happens) that encourages too many entries into a segment—assuring no one will make money.
A 14% IRR (internal rate of return) is great; 16% is Hall of Fame—but 60% returns are non-sustainable, while 8% is equally as bad. The price of deals is still too high; the exits have not been forthcoming and only a few companies actually get out on IPO. Their multiples are too low—especially when compared with the buyout funds over the past few years… But those buyout and private equity funds are going to have to put more money in, and it will take longer and longer to flip—consequently venture investing will look better—not because their returns are higher, but because the returns of the “competition” look worse.
It is the best of bad times.
Howard Anderson is the William Porter Distinguished Lecturer at the Sloan School of Management at MIT, where he teaches courses in the management of tech companies and dealing with Adversity. He is the founder of The Yankee Group and the co-founder of Battery Ventures. Equally to the point for this article, he is the founder of YankeeTek Ventures, which he closed down two years ago because he thought the venture capital model was broken.
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