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Tech Startups May Start Feeling the Pain

Funds aren't flowing so freely in Silicon Valley


So long, tech bubble of 2011.

Stock speculators and doom-mongers alike had such great hopes for the new tech bubble. Privately held shares of the hottest web companies commanded valuations in the tens of billions of dollars, ratcheting up with each SecondMarket auction. Social media brands that ventured into the public market surged. LinkedIn (NYSE:LNKD) left many, including me, wondering if the mania of the dot-com days had returned.

But so much has changed since LinkedIn went public – starting with LinkedIn’s stock price: It’s down 38% from its high point of $122.70, reached a few hours after it went public. And now a major investor is slashing its stake in the social network.

But more importantly, money is not flowing around so readily as it was this spring. The Fed’s quantitative easing has ended, and unending financial turmoil in Europe is making investors risk-averse.

In the first half of 2011, 78 IPOs priced on U.S. markets, up from 64 in 2010, according to Renaissance Capital. But the third quarter saw only 18 pricings, down from 33 in the third quarter of last year. Meanwhile, 20 companies withdrew their IPOs in the third quarter, compared with 11 for the same period a year earlier.

For much of 2011, however, the public and private markets have seen an unusual disconnect. The public markets grew so volatile at times that rivate equity seemed like a safe haven by comparison. While companies went public only to watch their stocks sink like a rock, the private trading on secondary markets saw valuations of names like Facebook and Twitter steadily rise.

Others had no problem raising money from venture capital firms, with late-stage rounds supplemented by even later-stage rounds that raised several hundreds of millions of dollars for web companies like Twitter and LivingSocial. If there was a tech bubble to be found, it seemed to be in the private markets.

But that may be changing, too. Venture firms have been raising less money than they are investing. A few years ago, many VC firms were turning money away from institutional investors, but no more. According to Dow Jones VentureSource, VCs invested $14.3 billion in startups in the first half of 2011, but raised only $8.1 billion. That gap has been growing since 2008.

Venture funds raise money to be invested over the course of several years, so the impact of that investment gap won’t be felt right away. But one venture capitalist, John Steuart of Claremont Creek Ventures, had this advice for entrepreneurs: “If you’re in the process of looking for funding, seed money or an early round, hurry up and get your term sheets signed.”

That prompted a discussion on Hacker News about whether — and when — VC financing will dry up. “The sky is falling,” one commenter declared outright. “The reality is that with the current financing environment, there will be a ton of “orphaned startups,” remarked another.

Needless to say, this will impact entrepreneurs, because it isn’t sustainable. This is a reversal of recent years, when there was more money coming into VC funds than they knew what to do with. But fears of a renewed recession is causing institutional investors to be more tight-fisted with their money. Many tech companies have been avoiding the volatile public markets because venture investments have been so ample, but while it’s not drying up completely, it may well be harder to raise.

The best names, like Twitter and Facebook, will never have a problem raising private money, but others might. That may prompt some to try for an IPO, but as we’ve seen the IPO market hasn’t been terribly accommodating. So for the first time in a while, web startups may find it hard to finance their future – just like the rest of the economy.

Article printed from InvestorPlace Media,

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