As we get ready for 2008 I thought I’d mention a few of the things that are striking me about the current entrepreneurial and technology economy and make a few predictions for the upcoming year.  As always, they are provided with the knowledge that predictions are usually wrong, but the process of making them, or thinking about them, provide useful touchstones.  With that, here are a few observations of trends that I feel will be of importance to the technology economy in 2008

The Credit Crunch is not the End of the World

From where I sit (which is as an observer and not a central banker), sufficient concerns have been expressed as to the availability of credit and possibility of foreclosures to chill consumer behavior.  As I mentioned in an earlier blog  on this subject, the attitudes of the US consumer were the key I was watching to evaluate the effect of the credit crunch on the technology economy.  Well, the consumer is frightened now – frankly it would be hard not to be with some of the end of the world reporting in the media.  But, I think that the situation is more like 2001 than 1929.  You might remember that the economy slowed significantly in the spring of 2001 in the aftermath of the bursting of the tech bubble, but would likely have been in full recovery by early 2002 if 9/11 had not occurred.  In the spring of 2001, the Fed and others acted to prevent a long term contraction by providing sufficient liquidity and market reassurance, and something similar is happening here.   

There are significant actions taking place to make a long term credit crunch unlikely – industry action to limit mortgage resets, the Fed and European Central Bank pushing liquidity into the banking systems, recycling of petro dollars into the US economy through equity investment (for example, Citibank) and other actions by regulators and independent actors. Collectively, they will provide sufficient liquidity and credit reassurance to prevent a long term crisis.  This is good news for the entrepreneurial and technology community, because, as I mention below, these sectors are internationally competitive and therefore absent a major economic collapse are going to be attractive sectors for investment.

Early Stage Capital Will be Hard to Find

The bad news for entrepreneurs is that the prevailing trend of venture investment -- the accumulation of capital into larger pools -- is going to continue and may accelerate.  Institutional limited partners, which provide the life blood for large venture capital funds, continue to favor later stage investments and larger funds.  And, in some important cases they are becoming generally less interested in venture capital as an asset class. This raises the possibility of fewer funds operating in the intermediate term.

This leaves emerging funds, like Amplifier, state venture programs (e.g, GAP Fund and DBED) and Angel investors to fill a large funding void.  Some new businesses will obtain capital from these sources, but many good businesses will not.  The resulting capital mismatch will mean that many interesting start ups will find that their best capital source will be their own financial resources or other methods of bootstrapping (see my earlier blog on bootstrapping).  Therefore, any prudent entrepreneur should be planning on bootstrapping to some extent, probably for a longer period than would have been necessary last year. 

The good news is that although true early stage capital will be harder to find, there will continue to be ample liquidity for later stage investments.  Because I am not expecting the general economy to collapse or significantly decline, current aggregations of capital in larger VC funds, as well as hedge funds will continue to provide ample equity capital for compelling expansion technology deals.  I am also anticipating that the M&A market for emerging technology companies will continue to be strong, albeit at an average purchase value that will reward capital efficiency and smaller equity rounds.

Web 2.0 Investment Is Maturing

Internet and software investment will continue to be strong.  However, if you look at consumer “Web 2.0” investment patterns over the last half of 2007, there is a growing sense of slowing of momentum in this sector. 

There is clearly a trend towards concentration, by that I mean that established networks like Facebook, Google, Yahoo, LinkedIn and MySpace are working mightily to become the dominant network for consumers who want to use the Internet for entertainment, information retrieval and social networking.  This suggests to many that a new consumer Web 2.0 business must either (i) have a way to utilize existing networks in innovative ways (for example, a Facebook application) or (ii) be of sufficient distinctiveness to challenge existing incumbents and create an alternative network.  If it is the former, then the economics are not necessarily compelling to a VC and if it is the latter, then the bar is higher.  The larger the incumbents become, the higher the bar. 

There will continue to be compelling consumer Web 2.0 businesses, and software innovation will undoubtedly drive another generation of VC activity in 2009 and beyond.  But, for 2008 consumer Web 2.0 businesses that cannot demonstrate a clear and compelling differentiator will find VC financing very difficult to obtain.

The Opening of Telecom

As I mentioned last year when looking at 2007, I anticipated that the issue of “network neutrality” was going to be of primary importance to the owners of wired Internet infrastructure.  Notwithstanding Congressional action, and some regulatory actions by the FCC, the situation is still open to significant debate.  You might have noticed that there is renewed concern about whether the network owners are discriminating traffic, be it certain heavy users of peer-to-peer data or users who are promoting controversial social agendas.  This issue is not going away, and is likely to continue to put pressure on wired network owners.

Meanwhile, the operators of wireless cellular networks are similarly coming under pressure to “open up” their own networks, by not discriminating in the services and products that can be offered on their networks, or requiring a burdensome economic participation in “approved” offerings.   Google’s offering of a software development platform and applications for cellular handsets, as well as its anticipated bidding for 700Mhz Spectrum (thereby becoming a wireless network owner) are going to put significant pressure on the incumbent wireless operators to open up their networks.  The recent announcements by Verizon and AT&T that tout the “openness” of their networks – basically that you can use a third party handset on their networks – are a marketing harbinger of things to come. 

How network owners will balance their need to achieve returns on investment in their networks with these competitive pressures is an interesting long term question.  Hopefully, competition and openness will make them more efficient and that innovation will outweigh the declining returns network owners will get merely by virtue of “owning the pipes.”  On balance I am anticipating that at least one wireless carrier, probably T-Mobile, will dramatically open up its network with the larger players eventually following along.  This will take a few years to fully play out, but I am anticipating that the changes will be significant enough to make cellular centric software and offerings an attractive area for renewed VC interest.

Internationalization

As I predicted last year, non-US equity markets are becoming ever more attractive to international issuers.  During the last year, the London market eclipsed the US as the primary market for IPOs. This is not a small thing.   This trend is likely to continue for a number of reasons: (i) the significant amount of liquidity that has been exported by the US to the rest of the world is being converted into Euros and other currencies rather than being repatriated to the US in the form of investment in US Treasury securities, (ii) the regulatory environment in the US equity markets continues to be difficult and expensive, and (iii) the decline in the value of the US dollar will constrain willingness to hold US Dollar denominated financial assets. That’s all the bad news for primary offerings on the US equity markets.

The good news is that technology and innovation continues to be something that the US does exceptionally well, and is an area where the US is internationally attractive and competitive.  As a general matter when the US Dollar declines in value foreign direct investment increases, because investment in hard assets (i.e., non financial assets) are driven by long term investment horizons.  Additionally, technology investment, particularly, in early stage technology, continues to be the best long term return investment class available in the US economy.  And, of course, as many parts of the world economy have become wealthier, markets for US products and services are much more compelling, particularly in a time of weakness in the US Dollar.

The net, net to all of these trends is that technology start ups should be thinking much more internationally, both as a source of capital and liquidity but also as a place to obtain customers.

Privacy and Identity

As advertising continues to migrate towards the Web, the tension between advertising providers looking to maximize yield and the consumer’s desire for “privacy” will accelerate. The problem is that currently the most effective advertising is centered around search or embedded ads that are tied to a consumer’s behavior.  (Looked at a Banner Ad recently?  I suspect not.).  Meanwhile, the growing use of the Internet as a social medium provides an accelerating ability for people to use anonymity to cause enormous harm (whether as a hacker, spammer or child molester to use three particular egregious examples). 

In order for the Internet to continue to grow and develop in importance there is a clear need for the system to develop mechanisms to manage an individual user’s on line identity to preserve privacy while ensuring accountability.  Regulators and key market participants are focusing on these issues more, and a number of industry wide standards, such as Open ID, are seeking to address this issue in various ways, as are numerous emerging companies.  I am anticipating that during 2008 you will see accelerating scrutiny of Web advertising methods, network identity and network security.  Whether you will see a more holistic approach that begins to balance the legitimate privacy rights of individuals with the economic imperatives of the Consumer Internet is an open question.  It will happen eventually, but probably not next year.

So those are some thoughts on large trends that will play out in 2008.  There sure seems to be a lot going on, and I haven’t even touched on some other big trends out there that will affect the wider economy. Things like the upcoming election, US Federal fiscal policies, and the war in Iraq -- you know, little things like that.  As we head into 2008 my best advice to entrepreneurs is to be flexible and creative. This is going to be a very interesting and probably volatile year.