Duck and Cover

The other day, I was talking to a friend of mine in New York who works in the financial services industry. I asked him how things were going there. His (sarcastic) answer, “Everything’s great! The dollar is strong, oil is cheap, Wall Street is looking sound, we’ve got a morally upstanding governor, and I just bought a large position in Bear Stearns. What could be better?”

Indeed, these are scary-type times for those of us in the finance world. This last month has been turbulent. The US economy is teetering at the moment, as the subprime mess starts seeping into many areas of the financial world not directly related to mortgages. At the same time, the dollar is weaker than it has been since the mid-$80s.

This last fact is especially striking when you compare the dollar to the state of the shekel. Sometime over the last couple of years, the humble shekel has transformed itself into an international monetary powerhouse. Since the beginning of the year, the dollar has lost more than 10% of its value relative to the shekel.

So, what does this mean for those of us who ply our wares in the local venture capital trade? Mostly bad news, but there may be a thin silver lining hiding in there somewhere.

The bad stuff: With the financial markets currently in a state of chaos and the US economy slipping (if not already slipped) into a recession. From our perspective, this has three main ramifications:

1. It will be very hard to exit portfolio companies in the States this year. A lot of big players will likely hold off on M&A activity while everything settles. At the same time Wall Street will also take a while to get over its jitters, meaning a rougher environment for IPOs.
   
2. Portfolio companies, especially those in the IT/Software space who sell to financial institutions are liable to miss their revenue forecasts as these institutions implement cost-cutting measures.
   Funds who have recently started fundraising may encounter problems with LPs getting cold feet.
   
3. The dollar-shekel situation presents a host of different problems for portfolio companies in Israel. This from the simple fact that they raise money in dollars but a lot of their expenses are in shekels. Which makes these currency fluctuations a big deal. Just to give an example, one of the portfolio companies I am involved with “lost” nearly NIS 750,000 shekels from the time the investment process started based on the amount they raised and the difference in the exchange rates over the last few months.

All this means that we need to help portfolio companies operate as lean as possible for the foreseeable future.

So, is there a ray of hope anywhere in here? Presumably, the new situation presents an opportunity for companies who can provide real cost savings to customers and present a compelling ROI in a relatively short time frame. As in all times of crisis, these companies can prosper.

From the VC front, all we can do is content ourselves with a bit of schadenfreude. For the past few years, as the markets soared, we VC types watched in envy as private equity and buyout funds posted huge returns. Now, as things swing the other way, we can smile to ourselves.