It's subtle, but official: Venture capitalists in Silicon Valley are feeling less optimistic than they have been. The Silicon Valley Venture Capitalist Confidence Index, compiled every quarter for more than a decade by University of San Francisco professor Mark Cannice, shows a decline in venture capitalist confidence.
At 3.89 out of a possible 5 points, that confidence is by no means low. But this is the first decrease the index has seen in two years. Depending how the next few months play out, it might be just a blip--or the beginning of a downward trend that would make it harder to raise venture capital funds.
Why are VCs feeling slightly less rosy about the future? A few different factors play in to their outlook. Here's what you need to know, and the best strategies now:
1. Maybe we've stayed at this party too long.
There's a general sense that Silicon Valley has been popping out start-ups so fast and for so long that at some point something has to give. "The Silicon Valley start-up machine would give the Eveready Bunny a coronary," noted Shomit Ghose, partner at Onset Ventures. Still, he said, there was enough new innovation to keep things going for a good while.
But if VCs are still hanging in there, some are experiencing what you might call relevance fatigue. "It's unclear to me how long VCs will subsidize experiments to see what else 24 year olds can do with their iPhones," said Dag Syrrist of Vision Capital. Moral: If you want VC funding, try to create something that at least has some hope of solving a real problem or meeting a real need.
2. Some technologies still have lots of room for growth.
The tech sector has seen explosive growth, but it's not done yet, according to Menlo Ventures' Venky Ganesan. "The major trends driving entrepreneurial growth remain intact--mobile and social for consumers; cloud and big data for enterprises," he predicted. "The world we live in is being refashioned by these trends and we are in the second inning of the game."
I'd add the Internet of Things, wearables (whatever happens with Google Glass, this is the way of the future) and the consumer cloud, typified by services like Spotify and Amazon Instant Video. All of these areas have a lot more growing to do and all are ripe for new ideas and new products.
3. Valuations need to return to Earth.
Are you hoping to work for a year or two and then retire forever on the proceeds of your sale or IPO? Maybe that will work, maybe not. Several VCs expressed the worry that start-ups are badly over-valued and perhaps getting too much initial funding.
"The excess of capital available to these companies is inflating both valuations and their wage costs," noted Robert Ackerman, founder of Allegis Capital. "The laws of gravity remain universal and, at some point, we can expect to see a reconciliation between hype and hope." Amid repeated mentions of the dreaded word "bubble," many VCs are predicting more conservative investments going forward.
4. A rising Alibaba lifts all IPOs. But for how long?
"With the Alibaba IPO both highly successful and, even more importantly, now out of the way, the deck has cleared for a number of new IPOs," predicted Sandy Miller, general partner at Institutional Venture Partners. "I think we will see strong reception and a good environment for IPOs the remainder of the year into early next year."
Perhaps. But a lot depends on the performance of the stock market in general, which is at an all time high and expected by many observers to suffer a significant "correction" at some point. In my opinion (if not the VCs) when and if that happens, the IPO game may be off for a little while, as it was in 2008.
5. Big tech companies will continue gobbling start-ups.
"Unlike the bubble timeframe, cash in tech companies' banks will provide a flow for robust returns," noted another VC who chose not to be named. True enough. Some observers have even accused Silicon Valley's tech giants of cynically letting starving start-ups do their R&D for them, acquiring those with potential value and allowing the rest to die on the vine. Thus, the big firms benefit from new innovation much more cheaply than they would if they had to actually pay their own engineers to create it.
But another reason for their continued acquisition appetite is that they may not have as many of those engineers as they want. "Acquihiring" start-ups in order to bring their personnel on board is common practice in Silicon Valley, and likely to continue as competition for talent worsens.
6. Is there life beyond the Golden Gate Bridge?
Not within the world of this report. And--I'll admit it--the VCs make a powerful case that serious tech entrepreneurs should head to Silicon Valley. "With over 10,000 startups in San Francisco alone, the Bay Area continues to attract the highest quality entrepreneurs to launch disruptive companies in the cloud, mobile and big data ecosystems," says Jeb Miller, general partner at Jafco Ventures.
Maybe so. But start-up activity in New York City is growing quickly. Tony Hsieh is busy turning Las Vegas into a start-up hotspot. Even Nashville is gaining a rep as a great place for entrepreneurs. So, sure, seriously consider the Bay Area if you're planning a tech start-up. But don't forget to think outside the geographic box.