Tips to survive the credit crunch

The U.S. economy may be teetering on the edge of recession. But even in the worst circumstances, investors say that steps can be taken to minimize portfolio damage and even to use a downturn to one’s advantage. Following are five tips for surviving and prospering during the lean times.

1. Pitch LPs

Matt McCall, partner with Chicago-based Portage Venture Partners, advises that while the money is still available, now is an optimal time to secure cash in anticipation of the next business cycle.

“I would argue that right now is a beautiful time to be raising a new fund, because if you go into this cycle with a war chest, you’re basically going to be putting your money out in the next three years, and you’re going to be harvesting it in years four, five, six and seven,” he says. “In other words, you’re going to be timing the cycle almost perfectly.”

The challenge, of course, is to persuade skittish institutional investors to sign on.

“This is a pretty nasty time to be out raising an institutional fund,” says Paul Kedrosky, a venture partner with Vancouver-based Ventures West and senior fellow with the Kauffman Foundation. “Institutional investors are trying to go to places where there is considerably more liquidity and will be cautious of the venture asset class.”

2. Shop for bargains

Bear markets present an opportune time to invest in companies that have executed on their business plans but are unable to access capital from public markets, says Lon Chow, a general partner with Chicago-based Apex Venture Partners.

“Investors that have some dry powder may be able to get into some pretty interesting deals,” he says, “especially if the IPO market is shut down and some companies still need capital.”

The hard part is finding deals. Draper Fisher Jurvetson Managing Director Warren Packard hypothesizes that—credit crunch or not—in any given year the same number of quality companies emerge that are looking for funding. In down times, VCs are less likely to be challenged with inflated valuations. However, in bear market periods, investors need to have better “magnets” to reach worthy management teams who may be spooked by a negative funding climate.

A powerful magnet can pay off. In the years following the dot-com crash, DFJ was among the most prolific venture firms and targeted global investment opportunities to mitigate against the domestic downturn. Some of the firm’s most successful investments—including Baidu, Focus Media and Skype—were initiated just after the dot-com implosion. “If an entrepreneur has identified a world-changing opportunity, we’re going to jump in and invest,” Packard says.

3. Cut burn rates

With a slowing economy likely to dampen revenue, venture investors should work with portfolio companies to adjust business plans and budgets to reflect market reality.

For companies that are not yet profitable (i.e. most startups), Packard advises investors to “make sure the burn rate is in proportion with the income stream so the company can survive.” But just cutting costs is not enough, notes McCall. The challenge is to reduce burn without sacrificing growth.

4. Find recession-resistant plays

Some investments always do well, even if in a slowing economy. The hard part is identifying them.

McCall predicts that few advertising-dependent Web 2.0 plays will prosper in lean times. However, he expects to see pockets of growth in some areas, such as performance-based advertising, which did well during the last downturn. For example, Performix, a performance play portfolio company that was later acquired by Doubleclick, “kept doubling sales each year straight through the recession,” he notes.

Earlier stage investments also have appeal in a downturn. Bill Elmore, general partner at Menlo Park, Calif.-based Foundation Capital, says it still makes great sense to invest in companies with a two-year product development cycle. “Most of the companies getting funded are small and in high-growth markets,” he says. “There is plenty of room for these companies to grow in any cycle.”

Equally important, Elmore says, is partnering with co-investors who take a long view on the market to make sure your companies continue to be well funded.

5. Relax

In panicky times, comfort-seeking investors are wont to ask themselves: What would Warren do?

The likely answer: Stop worrying. Says McCall: “It’s kind of like the old Warren Buffett comment: If the market shut down for 10 years, he wouldn’t mind because his businesses continue to grow.”

Even if the outlook worsens, Keith Benjamin, managing partner of Levinsohn Venture Partners, advises investors against any radical strategy shifts. “My prescription would be to take two Advil and ignore the economic news,” he says. “If I really thought there was going to be an economic downturn, I wouldn’t do anything differently. That’s just the wrong strategy for venture.”