Veloxrotaphobia: What the Economic Roller Coaster Means for Venture Capital

"How do you get out of this roller coaster of the relentless onslaught of bad news?" -- Bruce McCain, chief investment strategist, Key Private Bank

Reacting to the Dow's lowest close in almost 8 months yesterday, Bruce McCain voiced a fear felt by many investors: veloxrotaphobia, a fear of roller coasters.

It's a neologism that first appeared online in 2007 on the website unusualphobias.com, so it's not a "real" word per se, but then again, we're not dealing with a real roller coaster. But real or not, investors want off.

So what could veloxrotaphobia mean for those high-risk-lovin' souls in the first car, the venture capital industry?

DIGGIN' THE DOWNTURN? NOT SO FAST

Some have argued that starting companies during a downturn is a good idea, citing such factors as less competition, lower salaries, lower rent, cheap supplies and stimulus packages for small businesses that include such eye-widening enticements as subsidized loans and tax incentives. Indeed, some of the most entrepreneurial risk-takers see volatility and opportunity as virtually synonymous.

And sure, the entrepreneurial market will still be able to rely on the VCs that raise capital from public pension/superannuation funds. But those seeking to raise capital through VCs funded by institutional investors -- today's primary VC funder -- may encounter lukewarm responses, especially among experienced firms.

A 2007 Harvard study published in the Journal of Financial Economics looked at more than 30,000 VC investment decisions made over the past two decades, concluding that "the greatest response to shifts in the public markets is not by new or inexperienced venture capital firms, but rather by specialized organizations with considerable industry experience. These experienced venture capital firms increase their investments during market booms."

TAKING THE PLUNGE

We won't see third quarter VC investment figures for a few months, but yesterday's market plunge (the ninth biggest point drop ever) is being compared to the economic shocks that reverberated after the Great Recession of 2008. At that time, venture capital investment plummeted.

And it was a remarkable descent that challenged the legendary 58.6 degree, 60-mph drop of the Cyclone roller coaster at Astroland in Coney Island: VC investment activity in Q1 2009 was down 47 percent in dollar spending as compared to the previous quarter. An April 2009 report issued by PricewaterhouseCoopers (PwC) and the National Venture Capital Association (NVCA) described Q1 2009 as the "lowest venture investment level since 1997," noting that all major industry sectors experienced double-digit declines.

"Given the economic turmoil that began in the third quarter of 2008 and continued on into 2009," said Tracy Lefteroff, Global Managing Partner of the Life Sciences Industry Services at PwC, "it's not unexpected that the VCs would pause to assess the impact on their portfolio companies before again looking forward to their next investment." (Read: "You guys have fun on the Cyclone, we're gonna take a leisurely stroll on the boardwalk, look at the ocean, maybe eat some cotton candy.")

Some call it sector-tightenting. Others call it market-adjusting. Whatever it is, it’s deja vu. A report issued on Wednesday by Ernst & Young found that U.S. venture capital investment in the cleantech sector (alternative energy, conservation, power supplies, pollution and recycling) took a major dive, falling 44% in Q2 2011 to USD 1.1 billion as compared to the same quarter in 2010, which saw USD 1.9 billion in investments. But the year-on-year comparison isn't that bad, considering that the $1.9 billion cleantech investment total of Q2 2010 -- $978 million of which went to just five deals -- made it a record-breaking quarter.

MAKE MINE A DOUBLE, I MIGHT NEED IT

Referring to the growing fears that the U.S. is headed to another recession, the August 6th cover of The Economist asks the question that seems to be on the lips of everyone these days, and not just investors: "Time for a double dip?"

Kai Ryssdal, the host of the American Public Media public radio show Marketplace, doesn't hesitate in answering that iron-hot question. On the CNN talk show Piers Morgan Tonight, just a few hours after Wall Street markets closed on Thursday, he put it bluntly: "We can't head into another one because we're still in the old recession." Considering that all the year-to-date market gains have been summarily erased in just few days of trading, who can really argue?

"There’s still a recovery but it’s teetering on the edge," said Robin Marshall, director of investment management at Smith & Williamson in London. He may very well be right, but perhaps for the sake of the growing number of veloxrotaphobic investors around the globe, he might consider refraining from using any references to roller coasters -- at least until the next Congress is in session.

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NOTES

http://www.marketwatch.com/story/us-stocks-fall-hard-as-economy-weighs-2011-08-04
http://www.unusualphobias.com/Thingspage.html
http://www.people.hbs.edu/dscharfstein/VCIC_Article.pdf
http://www.nvca.org/index.php?option=com_docman&task=doc_download&gid=420&ItemId=93
Ibid.
http://blogs.forbes.com/toddwoody/2011/08/03/green-tech-investment-plummets-in-second-quarter/
http://www.sustainablebusiness.com/index.cfm/go/news.display/id/22750
http://www.nytimes.com/2011/08/06/business/daily-stock-market-activity.html

image: Cyclone roller coaster at Astroland, Coney Island, Brooklyn, New York (credit: wallyg, Flickr Creative Commons)