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Tough times ahead for Silicon Valley?

Financial crisis puts squeeze on tech sector start-ups.

By Jeremy KutnerContributor for The Christian Science Monitor / October 22, 2008

For Win Betteridge, the nationwide financial meltdown has meant one thing: opportunity.

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At a time when many people have been guarding their cash, the young entrepreneur decided to go shopping for other websites.
Mr. Betteridge is CEO of Genesis Interactive, an Internet company in San Francisco that runs, a social portal for video-game enthusiasts.

Eager to boost traffic to the site, he targeted an online video site called GameVee.

A clash of the titans this wasn’t. Both companies had similar size staffs and were new to the Internet scene. But Betteridge’s site had a larger following and was flush with cash from a successful round of fundraising in April. With the mood among venture capitalists turning increasingly cautious, GameVee’s money-raising potential was far from secure. In the end, for a relatively cheap price, GameVee decided to sell for about 2 percent of Genesis’ stock, valued at about $125,000.

“For companies that can stay afloat, there is opportunity,” Betteridge says. “This is very much related to the financial downturn. If you’re smart, the strategy might be to acquire.… Some companies that are in pretty desperate straits.”

After celebrating his acquisition and merging personnel, he did something that tells of lean times ahead: He cut his staff by 20 percent.

Betteridge’s aggressive conservatism is in many ways emblematic of the current uncertainty in the Silicon Valley, where young technology companies are preparing for trouble in the months ahead with less investment capital on the horizon.

The future was foreshadowed almost by accident earlier this month, when Sequoia Capital (one of the early investors in Google) sent a slideshow to its portfolio companies that featured a picture of a gravestone and the title: “R.I.P. Good Times.” Soon after, many in the technology sector were talking about what, exactly, was in store for Silicon Valley.

The TechCrunch blog, which offers analysis of tech start-ups, created a “Layoff Tracker” to chart the predicted flood of industry-wide downsizing.

In addition, venture capital investments in US-based companies have dropped over the course of the year, with a 7 percent fall in the third quarter alone, to $7.37 billion, according to Dow Jones VentureSource.

Whether this is indicative of a long-term decline in financing, though, is far from clear. The amount invested last quarter was less than any quarter of 2007, but more than in 2006.

“The capital is there. The question now is just ‘where do you put it?’ ” says John Taylor, Research & Financial Affairs Executive at the National Venture Capital Association (NVCA).

A more concrete source of worry involves the increasing inability of the venture capital firms to profit from the innovative companies they nurture. In the past three months, only one venture capital-backed company went public and only six have done so this year, down from 86 in 2007. Acquisitions of small start-ups from traditional buyers like Yahoo have also stalled.

“I’ve been following this for 35 years, and I’ve never seen a period where there is a lower amount of speculation,” says Scott Sweet, senior managing partner of IPO Boutique, a specialty IPO advisory firm based in Florida. “There is just no market for newer companies, especially if they show losses.”

Instead, venture capitalists are focusing their resources on the financial health of existing ventures that, in years past, would have been sold or gone public by this point.

Venture capital firms are also different from the over-leveraged investment banks of the world in that they actually have money – cash raised over the last couple of years in large part from pension funds and endowments.