Venture capital has long been heralded as an apprentice-style business where success only comes with ten years of experience and a gut that can predict the future. That was fine when it was a clubby industry making modest bets on companies within a 30 minute drive of Sand Hill Road. But as more money has flooded into the industry and tech has matured, finding the big home runs has become exponentially harder. Simply put: When you’re investing halfway around the world or trying to find the next Google amid a sea of me-too companies, let’s put the machismo aside and admit the industry needs some metrics, some methodology and some help. Check out the latest returns if you think I’m being too harsh.

This is why I thought YouNoodle’s Startup Predictor was a great idea pretty much the first second I heard about it. There was a lot of derision early on about the idea that a company could create an algorithm to predict how much a startup could be worth. (Ahem, not by me of course. YouNoodle predicted my book writing, blogging, column writing and TV show hosting mini-empire would be worth $21 million in three years. We’re still working on that.) But the algorithm takes the same variables that VCs weigh, like how long a team has worked together, what the goals for success are and metrics like Web traffic and buzz.

On Thursday, the company is releasing a new product called YouNoodle Scores that quantifies the buzz further. Unlike a vanity Twitter app that ranks the value of Tweets based on surface details like how many people follow you, there’s some serious methodology here, thanks to a partnership with Sean Gourley. Gourley is a Rhodes Scholar who’s studied how collective intelligence works, specifically how different cultural patterns, news reports and buzz lead up to break outs of terror attacks and wars. He found that you could predict the nature, size and timing of outbreaks by looking at all these factors. YouNoodle hired him to apply the same thing in the startup world: Analyzing traditional media, blog posts, Twitters, Alexa traffic patterns and other metrics over time to predict when and how a startup would, well, break out.

Conceptually, figuring out what all these patterns and metrics really mean will be even more important as we trudge deeper into this muck of a recession. Web 2.0 has become way too reliant on surface metrics with all of us thinking page views, unique visitors, Facebook friends and Twitter followers implies value in an age when we all know how to goose these metrics. If the algorithm works right, my guess is you see sites with fewer gaudy statistics actually scoring higher in meaningful buzz.

YouNoodle CEO Bob Goodson cites a company called Viikii.com, that jumped onto YouNoodle’s radar out of nowhere in October thanks to the algorithm. It was started by two Stanford kids, but I’d certainly never heard of it. Viikii makes subtitling software for Korean videos and despite its MIA status in the Valley echo chamber, the site has been taking off—it’s just been taking off in Korea. I can’t help but wonder what the scoring engine might have made of a site like Pownce that launched to wide hype and fanfare, but quickly tailed off in user activity and adoption.

It’s possible the new scoring engine may help YouNoodle inch towards a business model—the biggest area where I’ve had my doubts about the company. I don’t think VCs are a great market to buy any premium YouNoodle analytics, because there’s going to be natural skepticism that an algorithm can be any kind of substitute for their experience and judgment. But governments charged with investing in startups are a natural fit. After all, they are trying to act like VCs without the training or experience. Even if YouNoodle’s algorithm is right 30% of the time, it’d be a huge upgrade over funding companies in the dark. One of the company’s launch partners is the UK’s Department of Trade and Investment, which is currently charged with disbursing some one billion pounds into the London scene. (Full disclosure: CrunchBase is another launch partner.)

Of course for any of this to happen, the site has to work and, to be clear, I haven’t gotten a chance to play with it yet. (Yes, we all remember Cuil.) But as someone who’s covered this industry for ten years, I’m hoping that YouNoodle’s start up engine works well enough to give the venture capital industry just the kind of healthy kick in the pants it sorely needs. It’s only fair. Venture capitalists have certainly profited off of the Internet disrupting every one else’s businesses.

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As expected, the venture industry is seeing the fallout from the economic crisis, with fourth-quarter investments dropping to a total of $5.4 billion invested in 818 companies, according to a report from PricewaterhouseCoopers and the National Venture Capital Association based on data provided by Thomson Reuters. That’s a 33 percent plunge from the $8.09 billion invested in 1,051 companies in the fourth quarter of 2007.

With the exception of a few industries, these fourth-quarter numbers show a sharp pullback by VCs between the third and fourth quarters of 2008. Indeed, VCs are nursing their growing portfolios of later-stage companies that are unable to exit through a public sale or an initial public offering — and waiting for the economic fallout to subside.

As we reported after the third-quarter NVCA conference call, valuations are down for venture-backed companies seeking additional rounds of financing. With exit markets essentially closed, there remains a cluster of later-stage deals cluttering up venture portfolios. Pascal Levensohn, of Levensohn Venture Partners, notes that this is an expecially good time to get a better deal on later-stage companies willing to settle for early-stage valuations. “Capitalization models are out of sync with the reality of the market,” he says.

The MoneyTree data also tries to look on the bright side, noting, for example, that in all of 2008, VCs made the most seed-stage investments since 2000. They put $1.5 billion into 440 companies, compared to $1.3 billion into 450 companies during 2007. However, those seed investments fell along with all the other investments during the last three months of the year, with $199 million going into 62 startups — a 47 percent drop in dollar terms and a 43 percent slide in terms of companies over the fourth quarter of 2007. And the fourth-quarter dive caused 2008 to be the first since 2003 that venture capital investing has declined on an annual basis.

With venture firms pondering their investment strategies, so far startups in the media and entertainment business and cleantech are still seeing a slight increase in deals, making it appear that venture firms are pulling back most strongly from the software, semiconductor and Internet technology sectors

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Today’s headlines trumpet the loss of 598,000 jobs last month — the worst in 34 years — but what does that mean for Silicon Valley, the home of technology? In order to get a sense of what’s happening with venture-backed startups, peHub talked to a local recruiter, who says it’s worse than the dot-com bust was for the Valley. VCs see this recession lasting a long time, she said, hence the deep cuts.

In other words, if you’re really awesome, you might get a job (with a pay cut). Meanwhile, over at Fortune, the pessimists are speculating that this time technology won’t save us from this downturn, alleging that the dot-com bust wasn’t even this bad because that’s when Google was formed.

According to the article, technology won’t save us because there are no big new technologies to create jobs and boost productivity — and even if there were, no venture firms are funding them. That’s ludicrous. The big technologies tied to mobile computing, faster broadband and mobile broadband are going to make people much more productive wherever they are. Cloud computing is going to change the economics of information technology. And all of these innovations are pushing us toward — and giving us the tools to work in — an on-demand economy.

I think the way our careers and jobs are going to be managed is part of this change. A larger portion of the workforce (like it or not) is going to look more like freelancers or consultants, working on demand. That change means the government will need to step up with health care for the self-employed, and retirement planning will become an even bigger issue.

As for the funding issue, it’s true that VCs are throwing around less cash than before, but they’re still backing startups — even hunting for bargains.

Either way, the job loss and recession are hitting Silicon Valley hard, and the only way out may be the kind of shift in the way society functions. But if we’re talking about folks bold enough to build companies in their garages, I wouldn’t count them out for long.

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The crisis in the financial market is coming home to roost for startups of all kinds. Today’s Wall Street Journal has an article detailing the death or firesale of several startups in the last few weeks. It’s grim, but this is only the beginning for many venture-backed companies, as we reported back in October. Over the next few months, we’ll see continuing news of businesses giving up the ghost as their venture backers take a hard look at upcoming cash needs and decide to prune.

As Fred Wang at Trinity Ventures told me back then, it is a matter of figuring out which firms can make the best use of the remaining money in a fund, weighed against the portfolio company’s cash needs.

“It’s a little bit like poker in the sense that if the company is not burning a lot of capital and the cost of buying a card is low, it’s a little bit easier,” Wang says. “If $1 million buys them another 12 months that’s easy to call, but if the cost of a card is $5 million to $10 million then it’s a lot harder.”

Venture capital is a cyclical business that follows the fate of the stock market, so it depends on where a startup is as the cycle turns from boom to bust. Unfortunately, many of these unlucky startups are getting crushed under the wheel as it rolls through the downturn. Right now is a good time to work on an idea, but a bad time to be selling things.

However, innovation won’t just stop.VCs are still making selective investments in early stage startups at newly reasonable valuations, hoping those deals are ripe by the time the economy reaches the next boom.

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Amid an IPO drought and the economic downturn, one investor believes that the venture industry should take the amount of money it puts into startups each year and slash it by nearly half, to between $15 billion and $20 billion. That’s compared to the recent annual average of $26.51 billion invested over the last five years, or last year’s total of $28.3 billion.

I wrote yesterday about the triage beginning in the venture industry, and today I chatted with Fred Wang, a general partner at Trinity Ventures, a $300 million fund that does some 8-10 deals a year. Wang was optimistic about his firm’s portfolio, noting just a handful of cutbacks and one company that’s seeking a recapitalization in which Trinity won’t participate. But he was less sanguine about the fate of the venture industry overall.

As far as he’s concerned, the venture biz needs to cut back on investments. Wang argues that there’s still too much money backing deals. He believes that during the last downturn, more venture firms should have failed, but because there was still so much capital invested in VCs, private equity firms and other funds, the dot-com bust wasn’t able to last long enough to bring the industry back to a sustainable size.

“There was so much low-cost capital available, that it was inevitable that the balloon would re-inflate before it deflated enough,” says Wang. “This downturn could help the business get rightsized. We’re just waiting for the other shoe to drop after the last downturn.”

If he’s right — and others have made similar arguments — then startups will find less capital overall. That’s not to say that VCs will stop investing in companies (they can’t), but that with fewer VCs and less money, it’ll be hard to get a deal done. The fourth quarter of last year averages out close to Wang’s ideal size for the industry, which means that the last few months may presage the capital-raising future ahead.

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Now is a great time to start a company. Why? Because great people are available to join you, VCs are loaded with cash, and office space is available cheap. Everything is cheap and readily available in a recession.

Paul Graham says "If we've learned one thing from funding so many startups, it's that they succeed or fail based on the qualities of the founders." "Which means that what matters is who you are, not when you do it."

In good times all the really great people are busy doing fun projects...and not available to join you in a startup. In bad times projects are cut, people are laid off, and big companies retrench to improving the existing stuff. New projects don't get any budget. So, great people get bored and start looking for the Next Big Thing...a cool startup.



Raising money is a little harder, but not much. Good teams with good ideas can always get VC/Angel funding. In fact, VCs are sitting on tons of cash right now...and they want to invest it in hot new startups. Many VCs are reluctant to dump more money into an existing startup that is struggling, but will invest in a new startup idea. The promise is always more appealing than the reality.

Everything else is cheap and readily available too. Office space is always cheaper and more available in a recession. Existing companies will sub-lease space really cheap to offset some costs. Computers, software, networks, desks, equipment...everything is cheaper.



Expectations are lower during bad times so it is a good time to be in development mode, building a product, getting an audience, and starting a tiny revenue stream.

Customers are willing to try new things to save money in bad times. When things are going great they don't want to take risks on a tiny startup. If you can save them money in bad times...they are happy to deal with a startup.



Go for it! Now is a great time to build your great idea into a company.

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