After the Great Recession: What Will the Startup Economy Look Like?

Yesterday, in the first of a series of blog posts about how our world will look when the recession is over, we talked about what’s changing on the Internet: some media companies in search of revenues are becoming more like software companies, consumers rather than advertisers have begun to pay for products, and it seems likely that this in turn will encourage more of the web to be integrated into cohesive applications.

But having talked to a few VCs in the past few days, we’ve also been anxious about where venture capital will come from, and where it will go.

The Water Runs Out of the Hose
There’s an obvious reason startups are getting more direct about revenue. The money in the start-up economy today is like the water in a hose whose faucet was just turned off. Public companies directly connected to capital markets have already faced reality, but private companies haven’t quite had to.

Yes, many startups began to shrink in very painful ways last fall, but fewer than you might think have out-and-out died. Of the tens of thousands of venture-funded startups, only 10 have appeared in TechCrunch’s Deadpool since the beginning of the year.

Almost none has been marked down as far as the Dow Jones Industrial Average, which adjusting for inflation recently hit 1966 levels, when the U.S. population was 50% smaller. What this means is that if your startup were GE, your next round wouldn’t be, as you might hope, flat or maybe even a little up. It would be a down round, with an 85% discount off your price from just a year ago.

One reason private-company valuations aren’t dropping as fast is that venture investors are more patient than public markets; perhaps the economy will turn before many startups need money. But on the whole startups have more time because the hose of venture money is unusually long.

Most startups raise 18 months of cash from venture capitalists. Most venture capitalists in turn raise enough money for two to three years of primary investments in new companies, and well more than five years of follow-on investments. And even though everyone is trying to make that money last longer, it will finally and really start to run out later this year.

It’s painful to think that, even as the rest of the economy may begin to stabilize, far, far more startups could join the Deadpool this fall than last. The survivors who are able to raise money will have to compete not just with one another but with companies like Citi, whose per-share price was recently approaching that of Redfin’s.

The End of the Big Thing, And the Beginning
The startups who raise money will naturally try to make themselves smaller and smaller, so they can make do with smaller and smaller valuations. This is unavoidable.

But long-term, it’s the wrong way to go.

Newspapers were slow to recognize their golden age as a historical period with a beginning and an end, and in my gloomiest moments I wonder if ambitious venture-funded startups should consider the same possibility.

I don’t mean that invention itself will become obsolete, or that the best inventions are already taken. If you just think for five minutes, it’s easy to imagine a web – a world! – that could be so much better than the one we have now.

But the kind of invention that I really like, which brings together people of all stripes to launch a full-frontal assault on a ridiculously ambitious problem, may become increasingly rare.

The golden age of well-funded big ideas once seemed unbounded. When I got my first professional job, it was at a startup in 1995. The question we always asked ourselves back then was what Plumtree’s co-founder once asked me when we started the company: “Why not do the big thing?”

Now there are many reasons why not: the scarcity of money, the preference for acquisition, the obsession with first rather than best, the crab-like lust for cramped little niches, the cult of small. The trend had begun before money was scarce, but now that is the driving factor.

Startups have begun a retreat back to the garage, back to the rag-and-bone shop of the heart. It will do us all good to work our way out again. But it will take a long time, and many people will conclude that big ideas are, like some rare species of giant fish, extinct rather than waiting patiently in the depths.

This has happened before. The last time the Internet economy went bust, Oracle CEO Larry Ellison predicted that the era of major innovations in the computer industry had ended, leaving the battle for high-tech supremacy to Oracle, Microsoft and IBM.

Now all three of these companies have become less, not more, relevant, largely due to companies Mr. Ellison could hardly have accounted for: Google, Facebook and a completely re-born Apple. These new titans are run by people who think big.  And all three began their run when everyone else was walking.

Hopefully history repeats itself, proving Silicon Valley’s miniaturists wrong.

So yes, it will be hard to think big now, and harder still to get the money to do so, but perhaps the hour of true creative destruction, when new companies replace old companies, is at hand. It would be a great time, for example, to start a bank…

Tomorrow, we’ll look at how the recession is changing the shape of the real estate industry; for now, tell us whether you think the idea of the venture-funded startup is a long-term feature of the economy, or a 30-year oddity?

(Photo credit: the man with a hose was posted by Arutha on Flickr, the mola mola fish by MichaelHaas75 on Flickr)

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