A special thanks to Emily Mendell over at the NVCA, and to the NVCA in general, as the basis of this post is my color commentary on the NVCA’s position on the financial market crises that we are in the midst of.

The venture capital industry is neither directly involved nor immediately impacted by the financial markets crisis and any resulting bailout.

A venture capital investment is a long term (typically more than 5 years) investment in private companies and is not as vulnerable to shorter term market fluctuations in a traditional sense.  While I agree with the NVCA’s position here, I feel compelled to clarify that a venture capital fund’s portfolio companies might be potentially impacted in the short term by:

• constrained lending (for those companies with significant capital expenditure dependencies employing a debt strategy);
• a reduction in corporate information and communication technology spending (for those companies that offer such technology products and services);
• a reduction in ad spending (for those consumer internet companies whose business models are predicated on ad revenue;
• personal dynamics within portfolio companies wherein such people are affected by the financial crises on a personal level (mortgages, laid-off family/friends, etc.)

As most VCs invest only invest in companies having thought through the longer term capital requirements necessary for success and have planned for the possibility of development / market snafus and other such rainy days, such potential impact on their portfolio companies is manageable and a normal part of the company building process.

A venture capital investment does not typically carry a debt component like a buy-out transaction does so the industry, as a whole, is less impacted by the credit crisis.  VCs do not require leverage to do business.  I do, however, worry about the buy-out funds having witnessed debt-to-equity ratios climb from 2:1 up to as high as 12:1 during the past few years.  I also worry about any potential “drag” the buy-out funds will have on the ability of venture capital funds to raise institutional capital within the private equity / alternative asset class given the continuing capital commitments institutions have made to buy-out funds and the lack of shorter term liquidity.  While I’d like to think institutional LPs have utilized contingency planning as part of their investment process, I’m just not sure in today’s broader financial market.

Venture capital risk is very different from the risk which is now being addressed by Congress in that it is much more controllable.  Our risk is not systemic risk; it is typically understood prior to making an investment (see Arbiters of Risk).  While many venture backed companies fail, the simple structure of venture investing – cash and equity used to build a company — is very different than the complex financial instruments backed by the debt-dependent structures employed other industries (e.g. buy-out).

Ironically, in light of the recent failures and challenges in other asset classes, venture capital is being viewed as one of the safer investment alternatives for institutional investors today.  According to Thompson Reuters / NVCA U.S. Private Equity Performance Index (“PEPI”), the numbers are even more attractive (especially early/seed stage venture, ahem…):

The venture capital industry experienced its own crisis in 2000 with the technology bubble burst from which we learned many valuable lessons that are employed today.  While only time will tell, we like to think we have learned from our mistakes and have grown even stronger as an industry.

One of the upsides of the current economic conditions (if there is such a thing), is that valuations for start-ups have come down and continue to decline for most sectors.  As always, good investments are being made and will continue to be made in the months to come.

In light of all this, I am very excited about the prospects of venture capital as an asset class.  More specifically, I think now is an ideal time to be in early-stage venture capital (especially in Southern California) and, in fact, I continue to put my money where my mouth is here and will post more on the specifics of the SoCal venture ecosystem in the months to come.

My partner and I recently attended the NVCA’s 35th Anniversary event up in Mountain View so I thought I’d share a video from that event here as I think it is particularly relevant and timely given that it is an election year…that our public capital markets are currently in an apparent state of “flux”…and we here in The OC’s VC ecosystem recently had yet another outstanding VC in the OC event. For those of you looking to solutions to large, macroeconomic problems, I think you’ll find the answer in a word: Innovation. Support innovation and all that entails and things are bound to improve, in my humble opinion. Until next time, enjoy the video.

If you haven’t already registered for VC in the OC, get to it as tickets have been going fast and we’re on track to sell out (again) this year.  For details, and to register, visit VC in the OC.  Like last year, I will be moderating a panel and will take any questions thereof in advance.  The most common questions will be asked as well as a few “zingers” that I come up with real-time.  Please submit your questions to me via email.  Unlike last year, we’ve turned our program on its proverbial head and are featuring a panel of successful, local entrepreneurs (i.e., those that have done “it” before) rather than our standard panel of “VC talking heads”.  We are also very pleased to welcome back Mark Heesen from the NVCA who will once again provide an illuminating keynote on the state of venture worldwide…nationwide…statewide…and, of course, here in our own backyard.

Special Request — I will be wearing two hats come VC in the OC: 1) President of the Orange County Venture Group; and 2) Guest “VC Blogger” Moderator…so please do yourself a favor and don’t pitch me on any companies until after the event.  I’m easy enough to reach so you really shouldn’t feel the need to pitch me at the event.  Simply send me an email and we can go from there.