Rob Coppedge

Rob Coppedge: ’Tis the season of dire predictions and exaggerated negativity.

So, I regret the necessity to pile even more on our plates. But you can’t spend time with start-up and early-stage companies in the Seattle area (or nationally) and not realize that something is seriously wrong.

So many early-stage companies are having such severe difficulties raising new capital that we may well be on the cusp of a Bubble-like bloodbath—where companies go belly up in unprecedented numbers. Except this time it is not because of a pandemic of faulty business models.

Today, many high-quality companies tackling serious, important challenges are threatened, with severe implications for the much-touted U.S. “Innovation Economy.”

It’s never easy to raise money, but in this economic environment, it’s bordering on impossible. Worse, the situation threatens to persist.

The team at Faultline Ventures (sadly) estimates that venture capital won’t be “loosening” for more than a year. A few trends shed light on what’s going on:

1. Waiting It Out: Many early-stage companies pulled (or never launched) fundraising efforts during mid-2008, hoping to re-launch in early 2009.

2. A Dustbowl: By all reports, venture capitalists with "dry powder" have pulled back, waiting to get a handle on cash needs and time to exit for their current portfolio companies.

3. A Dry Year: VC funds are watching their own sources of capital dry up. A recent survey of institutional investors shows a significant percentage over-allocated to private equity. Capital calls are being canceled and managers are being told to hold off on asking for “re-ups” ... more reasons for VCs to make their current funds last.

4. The Limitations of Angels. The only good news for companies raising capital has come from high net worth investors and angel networks—but these pools of capital are reaching their limits. They cannot be expected to pick up all of the slack left by venture capitalists.

So, as we move into 2009, we expect the companies “waiting it out” will finally launch fundraising efforts—and the demand for capital will significantly outstrip the supply.

Angels won't be able to keep up and the traditional venture community will remain focused on less risky deals and on reserving capital for existing portfolio companies. While I hope to be proved wrong, we are predicting that these trends will lead to continued loss of early-stage jobs and the unwinding of early-stage businesses.

Worse, this will have a chilling on our Innovation Economy—shutting down a major engine of economic growth and job creation.

Sure, there may be bigger problems out there. But when billions are spent to bail out industries that need to shed jobs, it is troubling to see the innovation and job creation engine of our economy seriously threatened by a lack of (relatively) small amounts of capital. Consider: A mere rounding error in the Treasury’s bailout plan could make a huge difference for early-stage companies facing the choice of cutting back, shutting down, or embarking on a grinding slog on the fundraising trail.

There’s talk in D.C. of allocating a portion of the economic recovery package to start-ups and early-stage companies focused on health care, clean tech and green energy. If implemented well this could be a lifesaver. It goes without saying, however, that the Treasury is not well-positioned to distribute these relatively small checks to early-stage companies.

Much more effective is the notion of the government, through federal or state-level programs, functioning as an economic recovery “fund of funds,” partnering with existing venture capital firms and investment networks. These groups would bring experience working with early-stage companies, pre-existing deal flow and the infrastructure to add value—and could most efficiently get recovery funds into the early-stage market.

By clearly articulating goals aligning incentives, and insisting that sound investment principles apply, the new administration can successfully leverage existing capacity to “loosen” capital for early-stage innovators—with major impact. As the new administration’s financial recovery plans are implemented, let’s hope that we’ve seen the end of simply propping up legacy business models.

A meltdown in the Innovation Economy will have longer-standing (and potentially much more severe) ramifications than the long overdue restructuring of the U.S. auto industry. The best part is that early-stage companies aren’t asking for a bail out. They just want to execute their business plan and have a chance to generate a return on investment. How American is that?

Rob Coppedge has spent the past 13 years in early-stage health care venture capital. He is the founder and managing partner of Seattle-based Faultline Ventures.  Guest posts are the opinions of their authors and don't necessarily reflect the views of TechFlash or its staff.