investiledysfunction

I’ve been reading about how Silicon Valley is adjusting to the downturn as it’s a popular topic in many blogs.  Many prominent VCs have issued memos to the CEOs of their portfolio companies telling them to raise more money, control expenses and focus on profitability because things are going to be rough for the foreseeable future.  This is all pretty good advice.  Of course, the sinister, conspiracy theorists amongst those I’ve read feel this is an easy way to instill fear and get better valuations for VCs.  I’m not so skeptical so as to believe this.

But the outcome from this recession/downturn from an entrepreneurship and innovation perspective is going to be positive in my view for 2 reasons:

Reason 1 - As I mentioned in my Part 1 post, there are going to be a lot of unemployed or disillusioned people who say “I’m going to invest in myself instead of getting a job or investing in the stock market”.  These people will pursue new ideas, develop new technologies and will start new companies.  Out of this might emerge a few great companies and many more which will employ people and inspire even more entrepreneurs.

Reason 2 - This shakeout is going to get rid of a lot of crap ideas and companies.  There is no other way to say this.  Many of the “me too”  social networks or “iPhone/Facebook app” developers hoping to generate a userbase that they’d one day magically figure out how to ‘monetize’ may not make it.  They won’t make it not because they don’t have a cool idea that is fun and even potentially useful, but because many of these businesses were “built to flip” as a friend of mine at a prominent Sand Hill Road VC once commented.  And so they were never predicated on a real business model that could bring in more revenue than the dollars they spend.  This is a risky proposition and unfortunately, and such businesses don’t allow you to make it up in volume.

And while some of these ideas were marginally useful or fun as I mentioned, I also don’t know if they were solving real problems, e.g., building stuff that people really needed or finding a better way to do something that enough people cared about.

So what we’ll see in my estimation is the bar will get raised and better ideas will emerge and a new crop of more well-conceived startups will come forward.  With VC funding tightening up, entrepreneurs will need to do this.  Things that solve really big problems and that are built with an eye towards becoming sustainable businesses which are lean, mean and profitable are what will come into vogue.  A dollar and a dream may not be enough but a dollar, a dream and some serious discipline will be required.

In essence, for every Facebook, there will be many others that don’t have the backing to make it through the next several years.  And honestly, even if they did, being the social network for ex-convicts was never going to be that big (sorry guys).  I do think that many of these smart people who don’t make it out of this cycle will come back with better, tighter, more refined ideas the next time around, and this type of cycle is healthy.  Of course, this all only holds until the next bubble.

I had dinner with a good friend who works at a hedge fund this past week, and after we discussed the markets and our views on where things are going (sorry we didn’t come up with an answer), he made an interesting comment that struck me.  He felt that this downturn may be a good thing for the US economy for the long-term.  His logic was pretty simple.

• A lot of very smart people over the last many many years moved into careers in finance because it was lucrative and was seen as a path to quick riches.
• Back in the day, there was a similar belief about becoming a doctor for instance but it was not a “quick path” but one that existed for the best and brightest after many years of hard work.
• With this being a potentially protracted downturn, some of the current and many more from the next generation of smart people may go back to pursuing careers which in his words “are not just about trading paper”.  This means more innovation, entrepreneurship, etc from smart people trying to solve real problems.

I found this perspective quite interesting coming from someone in the hedge fund world - especially someone who is successful at it.  I also agree with him. Finance companies (banks, hedge funds, etc) have had a voracious appetite for PhDs and smart people in general who’ve helped them build complex derivatives and the like.  This downturn/recession may mean less of these people are inclined to go into or stay in finance and if this happens, they may look elsewhere, e.g., in science and math disciplines either with employers or in research organizations (mainly universities).  This is a good thing as it can lead to ideas and innovations that drive the next great wave.

I’ve seen this migration to finance firsthand.  I graduated from the Jerome Fisher Program in Management & Technology (M&T) at the University of Pennsylvania which is a dual degree program between Wharton and Penn’s Engineering school.  As I’ve met alumni from the program over the years, it has become apparent that fewer and fewer of us went down the engineering route in our careers (I’m guilty on this count).  The early graduates of the program were more likely to have worked in engineering fields for at least some time while with the more recent grads, most have sought to go down the business (especially finance) with a belief that their training from engineering would always be valuable.

It’s obvious that these types of attitudinal and structural shifts don’t happen overnight, but if some small segment of the smart people who previously pursued careers in the world of finance move towards entrepreneurship and innovation, this is a good thing for us in America as well as globally.

This doesn’t mean the finance types go away nor should they.  Someone will have to extend credit and funding to these entrepreneurs, right?

So are we in a recession? Or aren’t we? Who knows? Economists have a different view, and despite a track record as good as your local weatherman, we still listen to them for some reason.

But now a whole host are coming out with their wisdom after the fact not adding much to the dialogue but somehow their “insights” get picked up by the media. The first one is Lakshman Achuthan.  Achuthan is the managing director of the Economic Cycle Research Institute and feels the Fed didn’t act quickly enough when it begn cutting key interest rates last fall. The economic stimulus package also came too late, he said. (article link)

“If they had done all this in the fourth quarter … we might not have had a Bear,” he said in reference to investment bank Bear Stearns which collapsed last week.

“I think we’d be having a different discussion,” Achuthan said.

Achuthan pointed to the end of 2007, when inventories were low, as the time to act. A boost to the economy then would have spurred consumer spending and resulted in increased productivity, he said.

“There was an opportunity that was wasted by policymakers because they didn’t understand those dynamics,” he told CNN.

Thanks Lakshman. Where were you about 15 months ago?

The other economist who is also crying is John Ryding of Bear Sterns economics squad. In a note issues last Thursday, Ryding and team suggest “that the failure of the Federal Reserve between 2003 and 2006 to adequately raise the federal-funds rate to a more normalized level in part contributed to the downturn the market is experiencing - and by extension, the collapse of Bear Sterns.” (quote from 3/22/08 Wall Street Journal)

While I understand that it  must suck to be a Bear Sterns employee these days, I doubt Mr Ryding was arguing too much with the Fed’s actions when money was cheap and Bear Sterns stock price was above $100.

Being a Monday morning quarterback sure is easy, ain’t it?