I believe the current credit crunch can actually help venture returns. Why? Because it will help build momentum for the technology IPO market, which is what really drives venture returns. Investors have finally demonstrated a willingness to buy technology IPOs. There were some 36 technology IPOs in 2006. I expect to see that number roughly double in 2007.
In the middle of the liquidity crisis, VMWare went public, traded up sharply and stayed there.
Why do tech stocks now look better? Because alternative investments don’t look as attractive. Investors shied away from tech stocks for years, fearing the post-bubble risks.
Leveraged investing strategies were perceived as less risky. For the last five years, I’ve watched the skyrocketing returns from hedge funds and buyout funds with jealousy, wondering if I was missing something. I believe we have just witnessed a sharp shift in perception of the risk for those leveraged investing strategies.
I have taken a long-term view on the positive potential for venture returns, but admit it’s been a bit tiring to be in the less loved asset class. I have assumed that much of the returns from hedge funds and buyout funds have often simply been a function of magnifying small fundamental returns with significant leverage. Of course, there are some great managers in each class who deliver strong fundamental returns, but that seems to have been the exception. Less credit and/or more expensive credit will hurt these asset classes.
Fortunately, venture is not dependent on credit. I do not see a sustained credit panic and public market meltdown. I believe the financial markets will recover, albeit with tighter credit. The current environment could prove ideal for venture returns. My key assumption is that technology IPOs become more attractive as public market investors look for investment returns from growth, not leverage.
All this reminded me of Paul Simon’s song. As hedge funds and buyout funds may have hit their ceiling, there is a good floor under technology venture today.
Keith Banjamin is a managing partner with Levensohn Venture Partners. This post originally appeared on his blog, SF Venture.