How Does the Mortgage Meltdown Affect VCs?

Posted by on September 26, 2008 at 4:27 am.

I’ve heard today’s frequently asked question multiple times this week as many colleagues, friends and family put all financial categories in the same mental bucket. Depending upon where you are in your fund cycle and the industries you back, the answer varies. Luckily, venture capital is a long-term business and private company valuations/fortunes don’t fluctuate like public entities — particularly when the mess has mortgage roots (little direct tech connection).  However, there are plenty of indirect effects on VCs and the portfolio companies.

In honor of the $700B bailout being considered, here’s at least 7 ways the mortgage meltodwn affects VC funds.
1) Funds focused on financial technology investments are seeing customers disappear or cut technology spending.  However, companies with cost-saving products/ROI are still knocking down deals.
2) “Quant jocks” are on the market and smart tech companies are picking up the talent to squeeze ROI out of a microeconomic model, advertising arbitrage or customer value/acquisition. 
3) Portfolio debt from venture debt pure-plays (e.g. SVB, Square1) is calm, so far; but debt from diversified banks with mortgage exposure is nervous/gone — watch those MAC clauses.  This is a very different bubble burst from the tech bubble, which left SVB licking their wounds for years.

4)  Alternative asset classes that relied heavily upon leverage/liquidity, like hedge funds, are getting creamed and regulation could change/kill many models.  That means venture capital gets a growing share of alternative asset allocations.
5) However, as public equities drop in value, the relative percentage of an LP’s pool in venture capital grows even if VC valuations do not change — putting some LPs over-allocated in venture capital.  Weird huh: as public securities perform poorly, LP allocation rules can actually discourage investing in a better performing category like VC.
6) “Mark to Market“, one of the culprits behind the meltdown, is often derided by VCs who believe interim, illiquid valuations mean little compared to realized valuations.  Some bailout discussions include changing/removing mark to market — could that simplify VC valuations/reporting going forward?
7) VC’s in market for their next fund might as well hit the beach until all this blows over.  I’ve heard from at least one foundation friend that meetings with VC funds are being attended only as a courtesy right now.  LPs managing large pensions, foundations etc. are too busy ducking and moving money to really engage.

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