Venture capital mood cools in Silicon Valley

The consumer internet bubble that has been building for the past year in the venture capital world is set to deflate rapidly following the turmoil that has swept through financial markets, according to investors and entrepreneurs in Silicon Valley.

While recent stock market debuts such as those of social networking services LinkedIn and RenRen have attracted warnings of a bubble on Wall Street, the signs of financial overheating have been even more acute among private, venture-backed companies at an earlier stage in their development.

In the latest indication, Twitter last week raised $800min a private deal that valued the internet messaging company at $8bn, even though it is expected to generate revenues of only $100m-$150m this year.

The high prices have filtered down in recent weeks to companies at an even earlier stage in their development and with little revenue, creating what several investors referred to as the Valley’s new “Billion Dollar Club”.

“The events of the last two to three weeks have accelerated the end of the upswing of the cycle, and the inevitable bubble-bursting and downturn,” said Sameer Gandhi, a partner at Accel Partners, a venture capital firm that was an early investor in Facebook.

“I think it will unwind very quickly,” added a partner at another leading Silicon Valley start-up investor. “A lot of people who had their eyes set on joining the Billion Dollar club will have to take a big hair-cut,” – a reference to the slice that is now likely to be taken out of their valuations.

The emergence of the most active market for tech IPOs since the dotcom bubble more than a decade ago has this year attracted a new class of investors into “late-stage” private companies that are expected to go public in the next year or two. These include Wall Street banks such as Goldman Sachs and JPMorgan, which have invested on behalf of clients, as well as mutual fund groups such as T Rowe Price and hedge funds including Tiger Management.

But the share prices of recent IPOs have been falling – Pandora Media and RenRen, for example, are both down by more than 50 per cent from their peaks. Several investors believe that people drawn by the prospect of quick returns from late-stage companies are likely to retreat.

Concern that the red-hot venture capital market of recent months would not last had already prompted a race to raise cash as companies stashed money away while they could.

“The market is definitely cooler than it was a few months ago,” said Matt MacInnis, founder of Inkling, a start-up that makes software for digital textbooks. Last month the company raised $17m in venture capital, even though it has yet to spend any of the money raised in an earlier funding round this year.

“We looked at the macro environment and the stock market – we decided it would be a good move to have financing to see us through the next few years,” he said.

One Silicon Valley investor said his firm had been advising all its portfolio companies in recent months to stock up on cash while they could.

The turmoil on Wall Street is likely to be a mixed blessing for venture capitalists, many of whom had been hoping to capitalise on the stock market enthusiasm to float their more developed companies. However, they will also now benefit from being able to make new investments at lower prices.

“It’s definitely a boon to investors,” said Sudheer Kuppman, who oversees investments in India and south-east Asia for Intel Capital, the US chipmaker’s venture capital arm. The valuation of tech start-ups in countries such as India was likely to hold up better than those in the US, he said, although with many choosing to list their shares on Wall Street when they go public, they would not be entirely immune.

Regardless of the cycles in venture capital, the longer-term technology cycle tied to the social networking and mobile computing revolution still had plenty of room to run, Mr Gandhi pointed out.