Surviving the Downburst

The latest developments in the US financial markets look like a severe downburst from a severe thunderstorm.

A downburst is the outflow from a thunderstorm that is characterized by a massive downward airflow creating immense hazards for aircraft – a severe downburst can swat even the most powerful aircraft from the sky and create a tragedy.

 

The failure of Lehman and the acquisition of Merrill Lynch by BoA show the power of the current thunderstorm in the financial markets. No one knows when this will end but in the mean time there is a lot of collateral damage.

We have already seen the market interest in new stock offering (IPO) evaporate. Some investment bankers I've talked to believe that the US won't see a recovery until 2010 and that the IPO market likely remains closed for a long time.

As a result, the number of M&A transactions has fallen dramatically and typical transaction values are low and unappealing to investors and management alike.

I've written in the past about the critical need for early stage companies to conserve their capital and drive aggressively to break even. This latest downburst places even more emphasis on gaining control of your own destiny.

Here are a couple of areas I believe have higher risk in the current environment:

• Cleantech investments where the combination of capital requirements and later round pricing creates a mismatch of expectations between investors and management on exit values.
• Social media companies where valuations result from growth in user base without strong underlying business fundamentals.

Companies in both these areas will need strong investor syndicates with deep pockets (and willingness to invest yet more capital) or they will fail.

Despite these issues, I still see many new company proposals targeting these areas – time to get real folks! The winners in these areas have left the starting gate – the late wannabes do not get to run.

It's a timely reminder to look for the seeds of the next investment cycle.