On a day when the U.S. House of Representatives rejected the Bush administration's $700 billion financial bailout plan, investors said the venture-capital industry that helps drive Palo Alto's local economy may escape crisis.
"This doesn't impact our industry directly. We're not expecting to see all our portfolio companies fail because of this," said Emily Mendell, a venture-capital industry representative.
It won't be a replay of 2000's dotcom-bust for venture investors, according to Mendell, the vice president of strategic affairs for the National Venture Capital Association. Rather, this credit crunch stems from the failure of mortgage-backed securities. It isn't a product of weaknesses in privately-held, venture-backed companies, Mendell noted, calling venture capital somewhat 'insulated' from market turmoil.
Venture investors are long-term investors, she pointed out, able to wait until market conditions improve before moving a company towards an initial public offering or a merger or acquisition, the traditional exit routes.
Green technology and biotechnology in particular may have up to 12- or 14-year periods of development before investors have planned to reap returns, she said.
But the massive engine of innovation and investment that thrives in Silicon Valley is unlikely to be completely untouched by market troubles.
Because of weak markets, the current drought of initial public offerings — at its lowest since 1978 — may continue, Mendell said. Venture investors would rather hold onto companies than try to go public in a hostile climate. And the larger firms that acquire startups may tighten belts by backing off from buying new companies. As a result, returns on venture investments could slide, as venture investors continue to prop up their holdings with cash infusions, Mendell said.
And some analysts are pointing out venture-capital firms can no longer depend on cash from troubled institutional investors such as AIG, Fannie Mae and others.
The cold climate could cause angel investors to hesitate as well, according to Gadi Behar, head of Los Altos-based angel group Silicom Ventures. The wealthy individuals who invest in startups won't necessarily pause because of personal market losses and smaller personal bank accounts, he said. But they'll wonder whether now is the right time to invest in startups, given the horrendous market climate for public offerings.
"Some people have lots of money and a few million won't make that much difference to them but it's the atmosphere," Behar described.
The Dow Jones Industrial Average plummeted 780 points following the House's rejection Monday.
Personally, Behar and other angels in his group have recently transferred investments from high-risk areas into lower-risk areas such as Treasury bonds, he said, following a springtime talk from local investor Pat Mackim. Mackim predicted bank and market failure, and while the angel group was incredulous, they were also cautious, Behar said — and reshuffled their portfolios.
Wealthy Valley denizens will eventually want to spend again, however, Behar predicted. If the cost of investing in startups drops low enough — with more supply than demand — the local innovation economy could reach an inflexion point, where investors suddenly start seeing cheap startups as bargain-basement deals. In as little as a year, local startup prices could bottom out and then rebound, the angel investor said.
Beyond that, Behar said the investment community was taken aback by the scale of recent failures, including Lehman Brothers, Freddie Mac, Fannie Mae and A.I.G., among others, as well as the conversion of investment-banking powerhouse Goldman Sachs into a deposit-taking bank.
"I think we're all in a shock period right now. The size of the problem ... takes time to digest," Behar said.
In discussions with European and Asian investors, the Israel-born Behar said the loss of confidence in American markets was striking.
"They trusted the financial system in the United States and now they don't know if they trust it anymore. Is the United States going to lead in the future? I don't know."
One Valley company has already announced layoffs. Santa Clara-based Nvidia, a visual-computing software firm, announced last week it would let go 360 workers worldwide as a result of "current business realities."
The effect on local consumers may also be significant.
Paul Seto, a local banker, said that the local banking community had already been feeling the credit squeeze, which affects new mortgages and lines of credit for local companies.
"We will feel it locally," Seto said, with the credit market all but frozen. "Lines of credit will be reduced for companies" and people will have greater difficulty getting mortgages for new home purchases.
"It's a question of how severe it is and how long it will last," Seto said. "It will take a while for credit to loosen."
Local banks may not have the liquidity to support new mortgages and consumer loans. But the average person may not be aware yet of the severity of the credit crunch, he said, although "the average person sustains the economy."
Local venture capitalists did not respond to requests for comment for this article.
Venture analyst Mendell sounded an optimistic note, however, suggesting that laid-off tech workers could turn around and invent the Next Big Thing with newfound free time.
"There's no recession of good ideas. There's always opportunity here. It could set off a whole slew of entrepreneurs who get laid off from their jobs and decide to take a risk and start their own business."