Don’t Shop Hungry, but Invest when Full

Through the years I realized that I always have a hard time planning for dinner, right after lunch. After eating, I am completely full, and the idea of dinner sounds truly disgusting. It's funny, because I KNOW I will be hungry, but I just can't focus on dinner plans with a full stomach. Isn't it stupid? The same (yet opposite) phenomena happens when you go grocery shopping hungry. It's a simple and easy rule - you will save money if you shop after a good meal.

So – what does this have to do with venture capital?

Clearly, we are facing a very difficult period. And in these times, many prophets people are predicting the end of venture capital/startups as we know it. Others are a bit less pessimistic, but still focus on the difficult times that lie ahead, and the local resiliency that will be tested. I guess that's true, and 2009 will not be a great your for our business. However, if that's the case, there is a good chance that 2011 and 2012 will be great years. This means, that companies that will be funded now, will be ripe for success in 3-4 years, right when the crisis is over, and the economy picks up.

Jeff Bussgang from Flybridge capital wrote a great piece on this topic. His take is simple, short term Bear, long term bull. Personally, I couldn't agree more. Jeff reminds us all of the last downturn:

"But the VC and entrepreneurial community went through a far rougher period only a few years ago and most firms are run by executives who remember those times and remember the prudent actions required:  cust costs, but don't cut to the bone; raise more capital than your plans suggest you need to cover the dry period; in general, increase fund reserves and assume longer holding periods; with employees and investors, set expectations for patience and long-term business building rather than quick hits and quick flips."

What does this mean? Going back to the hungry/full analogy, it seems that investing in startups now is similar to planning dinner right after lunch. It's hard, but it's the right thing to do. The analogy also works in the opposite direction. Investing in good times is like shopping for grocery when hungry. Personally, I have done 2 deals this year (Confidela, and another one to be announced soon), and I hope to continue investing at the same pace. I think the 2008/09 A round companies will turn out to be real winners.

Comments

[Alex Lazovsky]

Danny, I read all your posts but never comment on it. But this time, I simply must do it and say that you are a bright man! :-)

Many times I told people that the best time to make venture capital investments is during or preferably at the beginning of difficult times (economic depression), but I rarely met those that agree with that. You are probably the first person (or at least one of the very few people) from the VC community who thinks that way.

[Aner Ravon]

I wish you're right, but I strongly differ.

The current crisis is far worse than the one of 2001 because it is much more fundamentally rooted. in 2001 a wave of terror-fueled-patriotism helped propel the economy past the difficult setback. In 2001 investment banking played a significant role in mediating between American savings and a shaky Wall Street. In 2001 it wasn't clear yet that the IPO market was over and done with when it came to startups. In 2001 the US administration has just been elected and it did not face elections, the strong anti Bush sentiment and a split congress. In 2001 the real estate market was not at a pitfall with millions of homes at mortgage default. Make no mistake, this crisis is much more significant than the one we witnessed. It hasn't reached Europe yet (and it will), It hasn't reached the consumer goods (and it certainly will). The new administration is still 5 months from inauguration and the ecosystem will go through a major shake up - all in all leading to lower minimum points and a much longer recovery.

2. While your rational analysis is right, psychologically I can't see too many early stage investments happening anytime soon. We all know VCs hate risk. Even if we ignore the impact of a market cleanup, it is safe to assume that nobody knows what will happen next. In the meantime the IPO market isn't happening and investment banking is gone. There are too many existing portfolio companies that need protection - can you seriously envision too many partners betting on new investments regardless of analysis?

3. Unlike 2001, VCs will face a real need of consolidation. New funds will not close and previously announced closings will not all materialize. The Israeli VCs will face this need in particular, because it will become very difficult to draw money into Israel otherwise. While this can yield a very good outcome in the long run, it would definitely contribute to further halting of new investments.

4. When the crisis is over Israel will need to face one of its continuously growing problem and that is the fact Telecom and Internet are in the process of becoming low tech. They are developed for less in India and in Eastern Europe, they are managed better from the US and the UK. Unless Modu becomes the new Nokia, high chances are that the Comverse era is over. Do note that despite the recent hype there hasn't been an Israeli internet success story since ICQ (I mean one of a global scale). Israel will need to refocus itself on technology that really makes a difference - alternative energy, clean technology and medical research. This is where the future relative advantage of Israel can be materialized. The internet talents will be recruited by infiltrating local operations by Yahoo, Google, Microsoft and the like and will serve global american companies and not local startups.

Now this doesn't mean anything when it comes to one particular VC or one particular investment, but at the macro level this isnt just a passing low end of an economic cycle. Far from it. As a matter of fact, I think we are still a long way from seeing the bottom.

[Daniel Cohen]

Being pessimistic is a feature, but I think you are wrong. Knowing now that 2001 wasn’t that bad is easy. It was dark then and people thought “we have never seen anything like this”. It’s all cycles, and this one will pass as well.

[Aner Ravon]

Not sure I am that pessimistic. Off course these are all cycles, I just think this one has just begun :)