The New Year is always a good opportunity to take a look back and forward, since it is a consistent measurement point, and at least in my case, thinking deeply is a better use of time than 18 hours of televised college football.  With that, I’ve been thinking some about the trends I see affecting the venture investment climate.  Here are some things that strike me as I think about 2007 and beyond.

Web 2.0

The Time Magazine cover story aside, there is a perception shared by many that “Web 2.0 is over.”  My view is that is far from the case – the underlying trends that caused the creation these new Internet businesses are now entrenched and further development is inevitable.  However, for those that equate Web 2.0 with explosive businesses sold for large amounts of cash, or Google’s sky rocketing public stock price, the YouTube acquisition may be the watershed.  What many Web 2.0 start ups are going to find is that there is not an exit for them – it won’t mean that they are not interesting businesses, or have not acquired customers.  And, without immediate exits, venture investors may look to other sectors and opportunities.

That’s the bad news, but the good news is that innovative software technologies cost less and less to create, so committed Internet entrepreneurs would be wise to approach their businesses as cash efficiently as possible, both to manage their capital requirements and also to ensure that if an exit comes it can occur at a price that satisfies the entrepreneur and the investor.  In other words, just as happened earlier in the decade, a fading of enthusiasm for financing Internet technologies will mask the larger trends – the Internet as a tool, and the things that it enables people to do, will continue to progress, and businesses that survive the times when investment is less in favor will be the winners when favor returns.  If you want an example of this, look at Google, which was largely financed and grown from 2001 through 2003, a time when consumer Internet was disfavored.

Bandwidth and Net Neutrality

Many of the most in favor investment sectors currently (mobile content, video, social networking and Software as a Service), have something in common – they assume that bandwidth will not be a problem.  In other words, if you think about the Internet as a rail road, there is an assumption that there will always be enough tracks to run fast trains all the time and every place.  That is a faulty assumption -- at some point available bandwidth will not be sufficient for demand. This will happen for one of two reasons: Internet demand will grow sufficiently to outstrip the amount of installed bandwidth or owners of the bandwidth will accelerate this trend by favoring certain utilization of their bandwidth to the detriment of other uses.  Rationing of bandwidth is a coming problem.

Basically, bandwidth is provided to consumers by private owners.  They build, maintain and sell the bandwidth.  To this point, the economic model has been to sell access to the bandwidth for a fixed price, and not to charge or otherwise pick favorites among the providers of the data transported by the bandwidth.  This model has been the underpinning of the so called “long tail” of the Internet – the small provider of customer shoes who can reach national customers through key word searches, or a blogger like Mike Arrington who reaches national prominence.  However, if these small guys had to pay for distributing their data, or if for some other reason bandwidth providers decided to favor other data producers, they would loose access to consumers.  You might have heard of the phrase “net neutrality” already, but if you haven’t, this is what it is about – will the owners of bandwidth be able to discriminate among the providers of data. 

Over the coming year Congress will likely address the issue of net neutrality, and how it determines to regulate (or not) the bandwidth providers will have a dramatic affect on the investment climate.  If as a software or media entrepreneur you are not familiar with this issue, you should make it your business to understand it and be ready to adapt.  And, if you have a new technology to provide bandwidth to consumers that leapfrogs the current owners, get ready for a large number of investors to come knocking at your door.

Energy and Economic Security

Although you would not be able to judge by the number of SUVs on the Beltway, this year the American consumer got a taste of the fragility of our current energy consumption patterns.  Whether you blamed foreign instability, the demand of developing countries such as China and India, or hedge fund traders, the price of oil was volatile and threatening.  There is a growing sense on both sides of the political spectrum that the US’s national security depends upon changes in our energy consumption patterns – this can occur either through conservation or innovation.

Certainly, if you look at investment patterns in Silicon Valley and the activities of some of the best respected players out there, a part of the VC industry already believes that energy innovation is going to be an area of rapid investment growth in the coming decade.  This is a trend that is going to take over a larger part of the investment climate, and become part of the national consciousness – when you see a cover story in Time Magazine, for example.  I expect that one or more of the Presidential candidates will make energy policy an important part of the campaign, and that Congress will at some point adopt further measures to promote investment in new energy technologies.

Public Offerings and Being a Public Company

The continued depressed level of IPO activity and the number of large companies “going private” to avoid being public companies, reveal a troubling trend.  The regulators clamped down in a big way after the debacles of Enron, MCI and others earlier in the decade.  And, some would say, in light of the current scandals surrounding backdated options pricing and skyrocketing CEO compensation, that they haven’t gone far enough.  But, there is a real question of at what cost have the regulators been successful.  The efficiency and availability of the US public markets has been a major driver of our economic development – quite simply the sale of interests in attractive investments is necessary for earlier investors to be rewarded.  Or, to put it more directly, a venture investor needs to be able to sell his investment to generate returns.

The current regulatory trend will have to correct itself.  This will likely occur in one of two ways: changes in regulation to make it easier to become or stay public or US companies will seek liquidity in international public markets.  My expectation is that you will see a larger number of technology start ups investigating listings in Europe, particularly London and Germany over the coming year.

What does this all mean to the entrepreneur?

• See past the initial hype and understand the larger trends. Build your business against the larger trends, and build it to last.
  
• Pay attention to Washington.  The government is going to be addressing issues that will dramatically affect the technology investment climate and however it acts it will create opportunities for innovation and venture investment.
  
• Understand the dynamics of exits – who’s buying companies and why.  How available is the public market to your company?
  
• Venture investment doesn’t happen in a vacuum.  You’ll note that I didn’t mention anything about the level of investment activity in 2006 being at a healthy level, or fundraising for larger funds continuing to be at historic highs. That’s because those trends, while illustrative of a healthy venture market, don’t predict future investment patterns.  Whether the trends I’ve identified above will be more predictive is a matter of time; let’s check in with each other next New Year and see how they went.