Wednesday, October 08, 2008

Tech Firms Prepare for the Worst

Technology companies and venture capitalists are bracing themselves for tougher times.

By Michael Fitzgerald

Ripples from the financial crisis on Wall Street are already being felt across the technology industry, with CEOs, entrepreneurs, and venture capitalists bracing themselves for much tougher times and considering how best to ride out the economic downturn.

Recent market turmoil has seen the technology-heavy NASDAQ drop almost 14 percent over 30 days. The fact that upheaval has hit even big technology stocks hard reflects concerns that an economic downturn will hurt these companies' bottom line.

But a more immediate pinch could be felt across the industry as a result of the tightening credit, says Andrew Lo, a professor of finance at MIT's Sloan School of Business. The difficulty of obtaining credit will "affect innovation," Lo predicts. "The capital is not there, and all investors will have a harder time raising funds."

The credit squeeze could prompt large technology firms that need plenty of capital to start looking elsewhere for extra investment, perhaps to countries with substantial foreign-currency reserves. An example of this approach came on Tuesday, when microprocessor maker Advanced Micro Devices said that it would spin off its manufacturing operations to reduce costs, using $6 billion from investors in Abu Dhabi.

Expect more deals like that one, says Paul Saffo, a seasoned Silicon Valley analyst and pundit. "Remember Japan buying America? This time, China's going to be coming in with the checkbook," he says. Such deals might stoke political controversy, but there will be little alternative for the businesses concerned. "When the white knights in the U.S. have no horse to ride, you know the deal's going to go through," Saffo adds.

Iain Cockburn, a professor of finance and economics at Boston University, notes that technology companies are normally more resistant to credit problems. "Tech tends to be less reliant on short-term credit," he says, adding that smaller tech companies and startups are relatively well placed to weather the impact of a downturn over the short term.

Even so, "if the short-term credit crunch doesn't get sorted out," Cockburn says, "projects that involve investments in new technologies [will] get postponed." He adds that established companies that have significant capital needs, like semiconductor firms and manufacturers, will also run into trouble.

Even small firms are already preparing for a much rougher ride. "The odds are for a big slowdown, so we're tying to conserve cash," says Dave Grannan, CEO of Vlingo, a speech-recognition company based in Cambridge, MA. Although the company has seen no drop in interest for its products, the economic outlook has forced Grannan to implement a hiring freeze (he had been planning to hire 15 new staff this month). He also hopes to raise $6 million to $8 million in extra funding from investors to help shore up the business.

Some businesses may be able to batten down the hatches, but venture capitalists still need to find a return on investments, so they are keen to play down the worsening climate. "Ultimately, money is always looking for a return," says Sim Simeonov, a technology partner at Polaris Ventures. "If you can show a great new company which is growing, then there may be a reverse dynamic of capital wanting to flock to it."

"We don't expect anything to affect startup funding in the short term," adds Isaac D. Barchas of Austin Technology Incubator. "But I am literally touching wood as I say this."

Greg Blonder, a partner at Morgenthaler Ventures, says that any recession will be tougher on middle- and late-stage companies, which need to raise money for growth. And he adds that the outlook remains foggy at best. "I don't think anyone knows the future well enough to say IT managers are going to cut back more than advertisers."

Some investors will refocus their attention on areas that are more resilient to the downturn. One example, according to Boston University's Cockburn, may be health-care technology. "Health care is kind of recession proof," he says. "If you've got cancer, you can't really tighten your belt and put it off for six months."

However, Steve Burrill, a venture capitalist specializing in biological sciences, is less sanguine. "This is a massive reorganization of capital market structures," he says. "Over the last 40 years, capital has been reasonably available, reasonably cheap, and reasonably consistent. In the future, none of that is going to be true."