As the US sees light at the end of its economic tunnel, is the Valley entering one?

By Sarah Lacy , written on December 20, 2012

From The News Desk

I was just reading through the National Venture Capital Association and Dow Jones predictions for 2013, based on interviews with more than 600 venture capitalists.

I was struck by how weirdly out of step the Valley continues to be with the broader economy -- a polarization you see even within different factions of the venture-backed startup world. Check out this quote by NVCA's Mark Heesen: "While anecdotally we have been hearing about 'light at the end of the tunnel' from venture capitalists and CEOs alike, this year's survey reminds us that we are not out of the woods yet."

Wait. What?

Mixed metaphors notwithstanding, I get what Heesen is talking about. The uncertainty of the fiscal cliff and other macro-economic effects going on are very real for most of the country. Even our own Bryan Goldberg wrote his thoughts about managing through a recession this week.

But Jesus, from where I sit in Silicon Valley, things look way different. For starters, I don't feel like anyone in this ecosystem has been in a tunnel over the last few years. Up until the last six months, people were secondary stock selling and partially liquidating their asses off. Seed money has been flowing like water. Facebook and Google are basically rock-em-sock-em robots, when it comes to fighting for talent. With the market being so tight, failed companies are routinely being purchased just for the engineers and designers.

Valuations have made everyone feel richer -- at least private ones. And occupancy of apartments in San Francisco is north of 90 percent -- with rents soaring 23 percent in the early part of the year alone. It's dramatic enough that our own Farhad Manjoo wrote a controversial plea for the city to ease up on its restrictions around building high-density housing.

Good God, if this is a tunnel, may we never see the light at the end of it.

Okay, so you might argue we're entering a tunnel. But truth be told, even the "corrections" going on are pretty mild, given the raging party that's gone on in the Valley of late. Sure, some of the big consumer Internet companies flopped entering the public markets, and overall tech stocks are trading at low P/Es. But not all is depressed. LinkedIn's stock is still well over its opening price and dramatically above its lows. Even Facebook's stock is well off its sub-$20 per share lows, although caution remains.

Meanwhile Google's shares are in the rarified $700-per-share territory, which is hasn't come close to since late 2007. Not too long ago, Apple was talked about as becoming the first company with a trillion dollar market cap and the only real reason it slumped a few weeks back was that it is just so big, money managers were overweighted in it. Weirdly enough, even AOL with its over-reliance on dial up and the money-losing albatross of Patch is performing pretty well stock-wise.

And, yes, there's a big Series A crunch coming, and 1,000 companies (or more, some argue) will likely go out of business next year. But these companies employ so few people and have been so lean up to now, that even a thousand going out of business would likely represent smaller job losses in aggregate than just Yahoo's layoffs in 2012.

According to the survey, CEOs and VCs are girding for hard times. Forty two percent of CEOs and VCs expect fundraising in 2013 will be harder, with 45 percent saying the series A is the toughest and 28 percent worried about the series B. Of those surveyed 65 percent of VCs and 56 percent of CEOs think terms will be more VC-friendly next year. Only 14 percent of CEOs and six percent of VCs expect terms to be more favorable towards entrepreneurs.

But it's not all a VC's world out there: When it comes to returns, everyone is more bullish on acquisitions than IPOs in 2013. (That's typically a bad thing, as there are very few home run, fund-making acquisitions.) And 44% of those surveyed expect the venture market itself to continue to contract. Only 9% expected more venture firms to raise more money than last year. A whopping 73% of VCs expect the terms they have to accept from their investors will get harsher.

Yet-- given all of that-- 49% of VCs expect an increase in returns and 78% of CEOs predict an increase in company valuations. Sounds like the venture world isn't just out of step with the US economy; it's out of step with itself.

Usually when there are this many mixed economic signals in the startup economy, it's a sign that things are about to get a lot worse. Everyone should be cautious. But as we wonder how big the tunnel we're headed into is, it's striking that much of the US economy is seeing the light at the end of theirs.

The Valley has been oddly out of step with the US economy for a while now. While things were tougher in the aftermath of the 2008 financial collapse, tech was mostly a bystander to the recession. Companies had to tighten their belts. Ad budgets and venture capital were harder to come by for a bit, but there were never the mass collapses or layoffs that the rest of the economy saw.

The big thing to watch is how well bets go on non-consumer technology in 2013. That's certainly the hope of those surveyed by the NVCA. The bloom is most definitely coming off the consumer rose. Consumer IT had the highest expectations in last year's survey and only 35 percent of VCs predict they'll invest more in consumer spaces in 2013. Compare that to 61 percent who plan on investing more in enterprise technology, and 57 percent who want to invest more in healthcare IT. It's been a long time since those sectors were sexier than consumer.

The worry is whether there's too much momentum. As we've written, many of the consumer entrepreneurs "pivoting" into enterprise are unaware of the uptime, quality, and security demands businesses expect -- yes, even with freemium software. More extreme are consumer companies, like Uber or HotelTonight, simply and bizarrely being relabeled as enterprise companies.

These sectors are truly ripe for disruption -- and, hence, big returns. But that only works if you actually build good products for those sectors.

[Image courtesy h.koppdelaney]