Promote My Site

Today's 400 point drop in the DJIA in the first three minutes of trading may be a temporary bump or a glimpse of things to come. So far it has recovered most of the loss, but if we're headed into a bear market we could be seeing the end of the Web 2.0 venture capital driven bubble.

Most Venture Capital funded companies think of themselves as cool, new startups that aren't affected by the goings on of Wall Street and huge companies. They live in their own world. How could something as far away as the NYSE affect their small business?

Most people don't realize how connected venture capital is to the health of the stock market.

• A bear market provides an inhospitable environment for an IPO, elminating a key potential exit for the VCs. Admittedly, there hasn't been a good IPO environment in a while, but a bear market won't help.

• A bear market hurts valuations for acquisitions. Big companies, if they have cash available, will pay less when buying the small companies because values are down all over. If your busisness plan is to get a lot of trafic and then sell yourself to Google or Yahoo, you're going to have difficulty when they stop buying or are offering less than the VC put into your company.

• A bear market hurts the ability of other businesses to buy your services. When the market goes down because of a recession, the big companies stop buying. Even if you don't sell to the Global 2000, the chances are your customers do. Or they're the ones getting laid off. Either way, a bear market hurts your ability to grow the business organically. And if you don't have a clear revenue model, you're really in trouble.

• VC Cash Calls threaten failure in a bear market. This is the big one that few people understand. When a venture fund raises money, they're really only gathering committments for funds. When they announce they've raised $200M, they don't have $200M in the bank. They've got $200M worth of committments from individuals and institutions that they can call and get money when they're ready to fund. The problem is that when the market turns south, a lot of these committments become less solid. Since it would be a very bad thing if a VC firm were to make a cash call and have it fail, they tend to call their investors and ask them if they have the funds to invest. If the answer is no, they don't tell anyone. They just stop funding companies. When a VC says "We're keeping our powder dry in this market" what they really mean is "We have no funds available to invest." Deals that would have flown through 3 months ago stop, and perfect deals get denied. Unfortunately, the VCs are all too willing to let you waste time delivering pitches when they know they can't respond. You can also see beauty contests that hit small snags blow up into dead deals.

The big one is the cash call failure. Few people understand it, it's the most insidious, and has the biggest effect on drying up venture capital.

So how does this affect your business? I'd say you're in a world of trouble if:

• You have no revenue mode for your business other than the idea that you're going to bring in a lot of traffic and figure out how to monetize it later or sell to a big company.

• Your revenue model is based upon advertising rates staying the same or growing. When the bubble breaks, a lot of VC money that was propping up the currently high rates for Adwords is going to go away. On the other hand, if your business model involves paying for Adwords, you could see your costs go down.

• You've taken a VC investment that allows them to take control of your company if you don't reach a certain milestones. "The company has stalled in its growth" is a favorite phrase VCs use when replacing the founder CEO with their analyst that needs a job because they don't have more deals to look at and need to trim payroll.

• You've taken a VC investment with the idea that you'll meet certain milestones and get the next round, or even worse, the next traunch. Yes, they can come up with a reason for withholding the next traunch that they've committed to even if you meet the milestones. They know you'll be fighting with decreasing resources and an increasing position of weakness.

• You've got a clear revenue model, but it's based on selling to startups funded with VC money. Take a look at your client list. If it's full of cool, new VC funded startups, it's time to look for new clients. You can calculate their life with their burn rate and the cash on hand, because they probably won't be getting any more. Don't let those invoices drag.

• You have become dependent upon a product or service from a VC funded company. If you've built a business where one of the core functions depends upon a VC funded startup, it's time to reevaluate your vendors. In fact, it's not a smart move to become dependent upon anyone that doesn't have a clear revenue model.

On the other hand, if you're lean and mean and haven't taken VC money and have a clear revenue model, you can do well in a recession. Recessions tend to trim out the slow and bloated, which can be your competition. Look at the companies that survived the first dot-com bubble -- they'll probably survive this one too. And a lot of the 100s of websites that make up the critical mass of Web 2.0 that do absolutely nothing will go away.

It's going to be an interesting ride.