Fred Wilson: The Coming Downturn

It's not just us.  USV partner and SAI contributor Fred Wilson, who has persuasively skewered much of the flippant "Bubble 2.0!" rhetoric, feels a sense of economic foreboding.  He also has smart thoughts about why--and about what entrepreneurs and investors should do about it (For our own concerns/recommendations, please see: Internet Recession Watch: Tracking the Signs):

Tough Times Ahead For The Web?

I was meeting with a web entrepreneur yesterday. It's something I do at least five to ten times a week.

This entrepeneur said 'but I worry that the coming downturn might have a negative impact on my business plan.'

Not 'a possible coming downturn', it was 'the coming downturn.'

And I found myself nodding my head, not challenging that assumption.

Why is it that I feel a downturn coming? It's not one single factor, it's a combination of factors, some based on real factors, others based on fears and other emotions...

First, the economy seems rockier than it has in a while. The housing market is no longer a driving force, its weighing on the economy. The fed's lowering rates in response but that makes the dollar and our markets less attractive to international capital. I have no idea if we are headed for a recession or not, but it sure seems more likely than it did a year ago.

Second, we are coming into a presidential election cycle. The democrats are looking stronger than they have in a while. The Iraq war and Bush are unpopular. There will be a lot of uncertainty over where our country is headed until the end of next year. That uncertainty has traditionally been bad for financial markets

Third, there's a looming crisis in the buyout business because banks have gotten more tight with credit. Less private equity buyouts will take one more positive aspect out of the financial markets

But none of those factors directly affects web/tech and the venture markets. But it does directly affect the psychology of the investors who fund the market and to a lesser extent the entrepreneurs who drive it

Then there's the parallels with web 1.0. This is where emotion enters the equation. I started Flatiron Partners in 1996. We had the wind at our back for four and a half years and then we got headwinds in the summer of 2001. We started Union Square Ventures to focus on renewed opportunities on the web at the end of 2003. We've had the wind at our back the whole way. My mind is trained to expect headwinds soon. I don't know that we will, but I can't help but expect them

And then there's the supply problem. The venture market in any industry (biotech, nanotech, green tech, comm equipment, web, etc) does best when the supply of new companies is relatively modest and the demand to invest in them is equally modest. Right now in web tech, we've got a huge supply of new companies and a huge demand to invest in them. That's not sustainable forever

And we are getting to the point that some web 2.0 companies are going to start failing. VCs will keep bad investments alive for a while, but they won't pour good money after bad forever. We've seen some web 2.0 companies close their doors and we are going to see more.

Finally there's the question of what's next? Is it semantic web? Programmable web? Social web? Yes, yes, and yes. But we are still seeing a lot of me too companies, slight twists on ideas that are now five years old. We are not yet seeing boldly new ideas, at least not enough of them to say we are now in web 3.0

Do we have to go through a shakeout to get to the next big move? I don't know. I only know that's what it took last time

So if you see the downturn coming as the entrepreneur I met with clearly does, what do you do? If you are a VC, I think you keep investing, but carefully. Its not a time to step on the gas. And focus on your existing portfolio, take gains where you can take them, and make sure you've got plenty of 'dry powder' for your portfolio

If you are an entrepreneur? Well that depends on where you are in your development cycle and what your goal is. If you want to spend the next five to ten years building your company, then raise a good amount of money and then put your head down and execute. If you are in it for the quick flip, get busy. That opportunity may not last forever

I know this post sounds gloomy. I am not certain we are headed for a rough patch. I am by month means sure of anything. But I think the probability of tough times ahead has gone up in the past year. And it seems to be creeping into our collective consciousness (or at least mine).

So let's talk about it and if it comes to pass, let's make sure we handle it better than we did last time.

Please feel free to comment below or on A VC here.