The bond market has an oft-watched concept of a Yield Curve - the relationship of short term rates to long term rates. Steep curves (long term bonds more than the 'normal' 3% premium over short term notes) signal growth ahead, as the bond market is anticipating a rise in rates due to demand for capital plus coming inflation; flat curves (long bonds about the same as short rates) signal a downturn, as the bond market is anticipating a drop in rates to get the economy going again.
The venture market has a similar but little recognized concept in the shape of valuations across stages of investing, seed to late stage. Early stage valuations are somewhat insentivitive to overall market conditions, as the founders get a certain amount for intellectual property plus incentives for the team and the rest goes to the investor, almost regardless of amount invested. In contrast, later stage deals are highly sensitive to overall market conditions, and in particular the IPO market.
In times such as now, the venture curve has been very flat. There is little valuation premium being paid for later stage deals. Between rounds of finance, the value is still not going up much, and there are still a number of companies who either should be mercy-killed or restructured back to early-stage valuations, even after tens of millions have been invested. In such a climate, it makes sense for venture investors to focus on later stage opportunities rather than take the considerable risk of early stage investing without the commensurate reward of a kick up in valuations.
The curve is beginning to steepen, signaling a return to normalcy. The public markets have been fairly robust for 10 months, and the IPO window is reopening. Investment bankers are combing later stage deals for potential properties to take public. Certain categories of ventures, such as VoIP, have seen valuation kickups more than other categories.
Yet we are not yet back to normal. The bankers have little visibility past this coming summer, and are concerned this IPO window may be a brief one. The economic growth of our bounce since Oct02 is not as robust as one would have expected, perhaps because the recession following the bubble was not as severe as most, perhaps because it has been cushioned by robust consumer borrowing to sustain lifestyles. We are nearing the peak of the four-year stock market cycle, the most predictable of all modern stock cycles, driven as it is by manipulation of the economy based on Presidential elections. (No surprise that the bottoms in the past 40 years have been as follows: 62, 67, 70, 74, 78, 82, 87, 91, 94, 98, and 02, and the peaks have fallen in between). Given all the pump-priming in the past few years, it wouldn't be a surprise if '05 was a bit of a downer, and maybe even '06. But '07 and '08 should be killers! And the venture curve should steepen drmatically into those years.
