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How is the economic crisis affecting tech companies?
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If you thought third-quarter venture capital investment news was bad (and it was), hold on — local venture capitalists predict the fourth quarter to be even worse.
The already-slow pace of VC-backed investments is going to slow down even more as early-stage investors react to the continued volatility of the public markets. And those reactions are ranging from slamming the brakes on some deals to gearing up on others — though most venture capitalists contacted this week said they are planning to be more selective during the fourth quarter.
Third-quarter investments in local VC-backed companies fell 23 percent compared with the year-earlier quarter. Jim Matheson, general partner at Flagship Ventures in Cambridge, said he expects fourth-quarter investing to be down nearly 50 percent.
“The common wisdom is that everyone will be doing deals more slowly and taking a kind of wait-and-see approach,” said Matheson. “I think if (investors) are looking for a reason not to do a deal, the environment provides them with that.”
During the third quarter, investments in local VC-backed companies declined to $769.2 million from $998.9 million during the year-earlier quarter, down 23 percent compared with a national decline of 7 percent, according to Dow Jones VentureSource.
Nationally, overall VC investment dropped to $7.37 billion versus $7.94 billion during the same period last year.
The investment decline followed the credit crisis but preceded the late-September record drop on Wall Street, which posted a 777-point decline in the Dow Jones Industrial Average in one day.
Portfolio companies are encouraged to streamline operations during downturns, but those are also the times for investors to make deals while other investors turn conservative, said Scott Maxwell, founder and managing partner of OpenView Venture Partners, a Boston firm targeting expansion-stage companies.
“We’re aggressively looking for our next portfolio company,” Maxwell said.
Information technology investments posted the fewest deals seen in a single quarter since Dow Jones began tracking the data in 2002, with only 270 deals in that sector. And the fourth-quarter outlook doesn’t appear to be much better as users of tech products are expected to tighten their budgets, said Nina Saberi, founder of Castile Ventures, a Waltham VC firm focused on early-stage tech investments.
The shift means portfolio companies need to be prepared for decreased revenue and ready to preserve their cash through the slump, she said.
This week, the DLA Piper 2008 Technology Leaders Forecast Survey reported that 75 percent of respondents said they have been hurt by the economic slowdown. Nearly half (47 percent) expect the economy will have a stronger effect on the tech industry than the bursting of the dot-com bubble at the start of this decade.
However, the last downturn proved that tough times can also be good times to start a tech company, according to Alex Benik, a principal at Waltham’s Battery Ventures. During that time period, Battery invested in such companies as Lexington’s BladeLogic Inc., which was acquired this year for $800 million, and Netezza Corp., which completed an initial public offering in July 2007, he said.
“For new startups,” Benik said, “it’s a good time to get going and put together a management team.”
And for existing tech companies, it’s a good time to get rid of anything that doesn’t contribute to the top line in the short term, said Bo Peabody, managing general partner of Williamstown-based Village Ventures.
Peabody, who expects investment levels during the fourth quarter to be comparable to last quarter, said investors will urge portfolio companies to focus on the short-term goals to get through the economic downturn.
“They should not be working on anything that won’t generate revenue within six months,” he said.
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