Wall Street fallout likely to chill innovation

Usually Silicon Valley floats along inside its own world. You can call it a cocoon or a bubble but its economy is usually separated from the wider world.

Obviously, the dotcom dotbomb had a massive effect on Silicon Valley and it took the best part of five years to pull out. But generally, its economy is dependent on the availability of VC capital and on the exits that help fuel the startup investment cycles. The ups and downs of the overall economy tend to have little effect on Silicon Valley.

This financial crisis, however, is different and it will have a chilling effect on Silicon Valley companies both large and small, imho. And here is why:

-- IT sales. The financial services sector is typically the largest customer for all types of IT equipment. Wall Street spends billions of dollars on servers, software and specialist systems used for esoteric and highly compute intensive tasks.

What will happen to the IT assets of Lehman, etc? Will all that equipment be dumped into the market and suppress sales of new equipment? That's what happened when the dotcom bubble burst--a massive amount of nearly new servers and network equipment found its way back into markets and hurt sales for several quarters.

-- Investment capital is the lifeblood of Silicon Valley. Will the pension funds now become less tolerant of risk and less willing to fund Silicon Valley VC firms? That's a very real possibility.

-- Smaller VC funds. If we have less VC money that means startups won't have the expansion capital they need. They will fold or have to settle for being acquired at a lower value.

-- Fewer exits. With the fall of investment banks, who will package up and market Silicon Valley's IPOs? This will further shrink the tiny IPO market forcing exit strategies to concentrate on acquisitions. But Wall Street investment banks have played a crucial role in structuring and helping to finance acquisitions.

-- Fewer Angel investors. Angel investors have become crucial within the Silicon Valley ecosystem as VC firms have largely moved out of seed-level investing and into later stage deals. The personal wealth of angel investors has been hurt by exposure to hedge funds and also to real estate markets. This means there will be less capital available to seed the next generations of startups.