This time last year I looked at the economy and made a number of predictions that at the time seemed to many to be pretty unlikely. I pointed out that although “uncertainty was the order of the day” by the end of 2009 the economy would return to positive growth. I also pointed out that concerns about the end of the financial world or a Great Depression II were overstated and incorrect. As I re-read my posting today, I came away with a number of impressions:
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For those of you who keep score, my economic predictions for 2008 and 2009 (which have generally proven out) were made at a time when they were very much against the conventional wisdom. The general themes of economic reporting were much more negative and very much tilted towards financial Armageddon.
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I was less successful in predicting how politicians were going to act. The level of philosophical grid lock – as shown in the Great Healthcare Debate of 2009 – has increased to the point where the ability for government to address challenges constructively has been severely constrained. There is plenty of blame to go around right now, but the common theme seems to be that while politicians argue about talking points very little conversation is being held around the true economic consequences of their disagreements or the actual economic outcomes of their stated positions. As I will address below, the political situation is a large wildcard in my predictions for 2010.
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The funding environment for entrepreneurship, particularly start up companies, really hasn’t improved when measured over the last two years, although it has improved since this time last year.
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The issues of net neutrality, privacy and intellectual property continue to be important and as trends progress a major crack between the regulators who are seeking to promote start up behavior and the courts becomes more likely. It appears relatively clear that where policies are shaped by the courts they are favoring the dominant player rather than the small company or entrepreneur. This is a troubling theme that I am seeing in areas of antitrust and intellectual property laws in particular. Absent clear direction from Congress many of these trends are likely to continue.
With those overall thoughts from looking backward, here are some of my impressions of how 2010 will unfold.
The Economy Will Grow Slowly but Not Uniformly
The overall economic data will show economic growth for the foreseeable future, but it will be low growth. The issue with the aggregate numbers is that in the absence of growing and broad-based consumer spending and renewed residential construction there is unlikely to be significant enough activity in other parts of the economy (trade and government spending) to dramatically overcome this short fall. Therefore, the aggregate growth numbers will show slow growth. The wildcard to this prediction, however, will be the actions of federal and state governments. The Stimulus Package passed by Congress last year allowed state governments to maintain employment of state employees and provide unemployment benefits to many individuals and families. If state governments are unable to provide a similar level of employment and benefits, the elimination of this spending in 2010 will likely cause the economic numbers to become worse, and possibly show a “double dip” recession.
As our politicians debate whether the US should have a budget deficit in 2010 and beyond, the near-term economic consequences of contracting government spending will most likely be obscured. Until the time that the US consumer is able to contribute meaningfully to growth, a removal of government spending will have a material and negative effect on the economy.
Because the Democrats have a workable majority in both houses and hold the White House, my expectation is that some sort of Stimulus II will come out of Congress later this spring. Based on this, my overall expectations are for slow economic growth – otherwise, the data won’t be pretty. But, this brings me to my next point….
The Aggregate Numbers Won’t Necessarily Be the Most Relevant to Entrepreneurs
It is widely agreed now that the current economic situation was caused by a glut of easy credit, and that growth is being held back as the economy “de-leverages.” By describing the situation in this way, commentators miss two very important points which should shape any entrepreneur’s thinking for 2010 and beyond.
Firstly, the use of easy credit in some ways artificially accelerated demand – pulling consumption from the future into the present. For example, people bought new cars in 2007 (rather than waiting until 2008 or later) because they could finance them so easily. Or, thought about another way – the current inventory of housing stock which is currently so hard to sell will eventually be consumed as the population grows. A significant portion of the consummation that occurred in the period of 2005 through 2007 would have occurred anyway, but it would have occurred from 2008 through 2012. Think of the current economy has having “lent” some of its consumption to the prior years – this consumption transfer would have the effect of depressing current economic growth under any but the most wildly optimistic scenarios. The point is that there are only so many cars and houses that people really can use at one time, whatever the economic circumstances. Therefore, the aggregate numbers for 2010 are going to be held down as the population’s consumption returns to spending money to satisfy current requirements, rather than future needs.
Secondly, where individuals and businesses are not “over-leveraged” and do not need to shed debt obligations (or in fact are in a position where they can take debt on), their competitive situation is dramatically better than it has been in decades. It’s important to remember that not everyone lost money in the stock market (or if they did, they more than made up for it by investing in oil futures or commodities), and not every consumer lost his or her job. Some companies are sitting on large cash reserves, and banks are likely to start to look to lend as the Federal Reserve Board sunsets some of its post-crash emergency measures.
Therefore, even if the aggregate numbers are anemic or worse, there are going to be pockets and regions in the economy that are going to be vibrant and provide ample opportunities for wealth creation and customer adoption. Entrepreneurs would be wise to spend less time looking at the newspapers and Wall Street and more time looking at whether their businesses are positioned to serve the needs of companies and individuals who are well positioned in the current economy. For those that focus on this, rather than focusing on general economic trends, 2010 will be rewarding.
Early Stage Equity Investment Capital Will Come From Individuals
As I have reported many times over the last two years, Venture Capital continues to migrate away from early stage investing. The White Paper I wrote on the topic provides a good summary of the factors that are causing this, so I won’t repeat them here. But, the point is that the great majority of early stage capital is going to come from wealthy individuals and families, rather than pension funds and endowments. Some of this capital will be aggregated into small funds like Amplifier and aggregations of Angel investors such as what John May does with New Vantage Group. But, the majority of the capital is going to come from individual Angel investors.
Institutional capital is investing in Venture Capital in two ways – investing in proven fund managers who manage large funds and investing in regions that have proven track records for generating returns. This is resulting in a Venture Capital industry that is configured to provide large amounts of capital in businesses that have proven business models (i.e., lots of revenue and customers) and favor companies that are in Silicon Valley and other regions in the world that are proven technology company hotbeds (Israel). Therefore, the shortage of Venture Capital is going to be both stage- and geographically-driven. For early stage businesses in Washington and the Mid Atlantic, the shortage will have the following effects on entrepreneurial activity:
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Finding early stage capital will become more inefficient, as it will require raising capital from a larger number of individuals, rather than funds.
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The few early stage venture capital funds that continue to operate will have a significant efficiency advantage.
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The level of effort required to raise material amounts of capital will dramatically increase, thereby putting a premium on raising as little money as possible in the early stages.
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Government funding from programs such as SBIR and STTR will become much more important.
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The proximity of the federal government as a customer will be the primary way that the disproportionate percentage of local entrepreneurs start and fund their businesses.
Tweet on This
Some time this year Facebook is going to go public and someone else is going to pay a lot of money for Twitter. This will cause some entrepreneurs to focus their efforts on being the next Twitter or Facebook and one or more nonsense articles about the “return of tech.” Don’t be fooled – those events won’t be the beginning of a trend, they will be the maturation of a trend that began a number of years ago. Here are some trends that I would recommend entrepreneurs focus their efforts on:
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Creating technology offerings that make Small Businesses more profitable. Small Businesses are the backbone of our economy, and they are being squeezed by the current economic climate. Find ways to improve their margins and they will beat a path to your door.
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Data integrity, privacy protection and security. Think that the world was a dangerous place for your PC? Wait until your Android handset is operating on a 4G Network and some Russian cyber hacker sends your electronic banking data to his server in Odessa.
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Electronic commerce. Two years from now we will be using our cell phones instead of charge cards.
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Cybernetics. We are closer to the 6 Million Dollar Man than you might think.
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Healthcare delivery, IT and innovations. Somehow it seems that people have this irrepressible need to live forever – or at least try to. Healthcare is going to be rationed in some way, either by government or by cost. Either way, innovations that lower cost or improve outcomes will continue to be rewarded.
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Energy. Oil is $80 a barrel when the world economy is growing slowly. Billions of dollars have been placed in commodity hedge funds. Energy from oil is not getting cheaper. This makes lost of other alternatives rewarding. And, let’s not forget that the US Government is looking to promote changes in energy utilization and consumption (yes, I think that a Carbon Tax Bill will pass Congress this year).
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Material sciences. There are some really innovate things happening in labs and academic institutions. Many of those ideas are going to be ready for commercialization in the next five years.
Don’t Count Out the Telecos
Pity the poor telcos and cable companies, it seems everyone wants them to open up their pipes without discrimination. As technology deployments such as the iPhone shows, it is possible for consumer demands to rapidly outpace the supply of bandwidth. This is going to be a greater problem for the cellular carriers, the telecos and the cable companies as demand for multimedia content will outstrip the supply of bandwidth. This bandwidth scarcity will provide an economic rationalization for the carriers to allocate their bandwidth to favor their own offerings – in other words, net neutrality will have a compelling counter argument – “if you want us to build more bandwidth I need to make a profit.” Get ready for higher monthly data charges and cable fees. And, if you are a start up, don’t assume that you will be able to succeed without the financial participation of the industry incumbents.
Inflation (Or, not)
If I had a dollar for every pundit who is calling for high inflation in the next few years I would have a hedge against inflation! More seriously, I don’t agree with this viewpoint for a number of reasons. The most popular reason given for inflation is that the “Chinese will stop buying US debt” and the Dollar will decline and interest rates will go up precipitously. There are also those that point to the economic history of Germany and the Weimar Republic and state that it’s only a matter of time until we are purchasing hot dogs with wheelbarrows full of cash. While in the longer term I am concerned that the US economy will lose its international relevance if certain current trends continue, this is a long term (meaning 5 to 10 year problem) and not a near term problem. There are many reasons for my conclusion, but in summary they center around the fact that the Chinese and US economy are locked in a cycle of co-dependence that is unlikely to be broken soon. The Chinese economy needs access to our consumers and they need a place to export unemployment. This is a huge political problem, and will need to be addressed for the US to return to rapid economic growth. Since I am by nature an optimist I believe that the US government will ultimately raise taxes or lower expenditures. But, even if I am proven wrong (which is always possible since I have proven myself unable to predict political actions) it will not be an issue for at least the next few years.
Up, Up and Away Goes the Stock Market
Absent a widespread economic calamity (a large terror attack or some other Black Swan), the stock markets are going to have another solid year. Why? Because there is no where else for the money to go. As I mentioned above, not everyone lost money in 2008 and 2009. There is a great deal of individual and national wealth in the world today. Prevailing interest rates will remain historically low, and the US dollar will be relatively stable. So, the market will continue to receive greater allocations from professional investors and hedge funds. Individual investors will come back into the market as the year progresses, as they compare the .005% they got on their CDs with the 27% they could have gotten in the stock market. This will be good news for private equity and venture capital funds that are looking for exits. So, you should see signs of life in those industries and a new cycle of fundraising later in 2010. It won’t be early stage capital, but it will be capital available to finance business expansion. A secondary effect will be that banks with better balance sheets and profitability will be able to raise additional equity capital. This will allow them to lend more as the year goes on.
Bank Loans Will Become Easier To Find
The banking industry is going to continue its segmentation into two types of banks – regional players that did not over expose themselves to the mortgage frenzy and national banks that got massive government subsidies to survive. The banking industry is going to consolidate further. The bad news is that this will limit competition and alternatives for businesses. The good news is that as the year progresses banks that are in a position to lend (either because they can get cheap capital from the market or because they were never really threatened) will have an economic incentive to lend. The returns from maintaining balances at the Federal Reserve will be less appealing than lending to businesses. This is, by the way, is the mirror image of what I wrote about above with respect to segmentation – the credit worthy are going to have some tremendous opportunities.
So, as has become an annual rite, these are my thoughts on the world that entrepreneurs will face in 2010. If this year turns out like the last two, I will be right about some things and wrong about others, but the one thing that has been true for the last three years – entrepreneurs will have opportunities to grow businesses and succeed if they stay focused on why they are in business and who is their customer.
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