Here, meaning in Silicon Valley, we’re not waiting for Obama – even if we look forward to his injecting physical and psychological stimuli in our economy. A week ago, our President-elect was politely spinning the “there’s only one President” line, meaning he didn’t want to interfere with Bush’s struggle to right the ship.  But, this Saturday, Obama took over, of sorts, the traditional weekly presidential radio address, also carried on YouTube. Full text here.  This is the new régime: 2.5 million jobs to be created, rebuilding the nation’s infrastructure, energy, ecology.  The works, the public works.  There is an obvious message here: the situation is so bad and the Bush administration so lame (as in “lame duck”) that, presidential transition niceties be damned, I, Obama, must grab the bully pulpit – right now.  Congress must get to work on my plan without waiting for my January 2009 Inauguration. This makes good sense as well as good PR, we’ll see if Congress brings itself to follow with effective – and clean, no pork barrel -- legislation.
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In the meantime, we’re trying to adapt. But to what?  We have no idea of the depth and duration of the current crisis.
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For a simple example with far-reaching consequences: Will unemployment reach 8%, 10% or 15%?  With the latter number, we’ll have a revolution, social unrest resulting from massive suffering.  We really never much more than 10% unemployment in the last 60 years, the worse numbers happened in 1982-83.  As for the 8% number, with week after week of bad news, it increasingly looks like a rosy, overly optimistic fantasy.
Another example, Citigroup. Only a fortnight ago, the CEO, Vikram Pandit kept claiming they were uniquely positioned to weather the storm. But, at the end of this week, the $100 billion-a-year group saw its shares drop below $5, its market cap swoon to a little over $20 billion. This is because Wall Street fears what it doesn’t know.  In Citi’s case, are there other surprises in store?  Will we discover liabilities triggered by someone else’s default, the now familiar exploding dominoes?  For example, auto loans and credit card debt total something like $2 trillion, most of which has been sliced and diced, securitized and those securities securitized again. I’m not making this up, it’s called CDO (Collateralized Debt Obligations) Squared.  (See here for an explanation of securitization, a good idea when applied in moderation.) If the ailing Big Three collapse, what happens to auto loans and to the twice derived securities based on auto loans?  Financial experts can’t or won’t tell. This is but one example of the financial land mines still out there.
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Back to venture capital, we don’t know how much to cut back. Should we put some of our companies in hibernation?  Close some?  Or just “trim the sails”, conserve cash while we keep developing the product or service we invested in and wait for the economy to restart. Chances are a few competitors will have died in the meantime and we’ll emerge stronger than we were when the storm started.  This was shown to work in the last crisis, when the Internet Bubble burst. But this time it’s much more serious, we now know it’s the biggest crisis since the Great Depression.  Still, many of us, our firm included, are writing checks, both for the next stage of growth of existing companies and for new ones -- more carefully selected than ever.  The time to maturity of an “early stage”, true start-up investment ranges from three to five to seven years, even.  This time interval bridges a recession.  With adequate cash reserves we shoot towards the other rim of the canyon.  Venture investors are, by nature, optimists.
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But reality intrudes.
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First, running an adequately financed start-up can cloud the mind of even the best CEO. The context: overnight, Cisco decides to lay off all its contract “employees”, actually they’re not actual employees, that’s the idea, easier to hire and fire.  Sun Microsystems lays off 15-18% of its work force (see Cnet's layoffs Scorecard here), Yahoo! prepares another RIF (Reduction In Force, now a verb: I’ve been riffed).  Every big company curtails travel and other discretionary expenses.
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So, amidst the bad news, we go to a Board meeting where the equanimous CEO proposes salary raises for everyone.  We’re making good progress, people have been working very hard, they merit an increase. We ask the gent: Are you a true free market capitalist?  Of course, replies the CEO with barely contained indignation – and, now, a smidgen of worry.  Why the question?  Because merit, professional achievement, performance, all translate into someone’s position in the job market.  Why do you think we pay you more than your very good receptionist?  Because we’re philanthropists or because the job market says we must in order to gain access to your services?  Look at the job market outside, with thousands of people laid off within a 10-mile radius.  And now, tell us: What is the free market saying about salaries right now, going up or going down?  Some CEOs need to be loved by their employees, a dangerous indigence; they’re tempted to use our money to buy, if not love, expressions of gratitude.  If this sounds harsh, let’s consider the alternative: raising the company’s “burn rate”, monthly expenses, to the point where it runs out of cash before the economy recovers.  Then, everybody loses, salary and stock options.  Speaking of which, we’d rather increase everyone’s share options than salary; we trade today’s cash for a bigger share of the pie.  A well received trade, almost without exception.
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Reality intrudes upstream as well. Downstream being us VC putting money in companies, upstream is when investors, Limited Partners, LP, invest in our investing activity. Say we have a $200m fund with 10 LPs investing $20m each.  Actually, the $20m number is a commitment, the LP doesn’t transfer the whole amount at the beginning of the fund, we start with 10% to 20%.  Over time, when needed, we make Capital Calls, we ask LPs to wire additional funds as committed.  You begin to see the coming trouble.  In good times, everything goes smoothly, the LPs promptly honor their (contractual) commitment and wire their share of the Capital Call.  But, today, some LPs are flat broke, insolvent.  Imagine you have (had?) Lehman Brothers as one of your LPs.  Where, whom do you get the Capital Call money from?  Troubled institutional investors can’t or won’t honor Capital Calls.  This happened when the Internet Bubble burst.  Fortunately, at the time, there was an active “Secondary” market, places where a defaulting LP could find someone willing to take their commitment over -- at an attractive discount.  In other cases, the General Partners, GPs, in the venture firm obligingly bought the defaulting LP back – at a “friendly” price.  This time, with little in the way of a Secondary market, we’re likely to see the financial crisis impact some unlucky venture firms – and their portfolio companies.
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There are no atheists in foxholes, said the First World War joke.  Soon, we’ll see how many pure free market capitalists are left in today’s financial craters. -- JLG
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