At the end of the day, if you're a VC you've raised a fund to invest, not sit around and wait to see what happens.
What is the outcome one could hope for by not investing in promising companies? Waiting for lower valuations? Weeding out the riff-raff?
Is that the best use of a fund's time?
There are going to be good and bad companies no matter what the rest of the economy looks like. Figure out your thesis and stick to it when you invest. But don't just sit there.
I think part of Mark's point is that they need to reserve funds for the portfolio companies which will need another cash infusion. They've already invested x in company A. If company A needs another 2 million to reach profitability, they may not be able to raise it from another firm. The VCs are being prudent and cautious to ensure that they can keep their existing portfolio companies going.
Remember, they aren't looking for 10x returns, they're looking for 100x+ returns. They know their is risk for their portfolio companies and need to make sure they look after their current investments before bringing on any new investments.
>What is the outcome one could hope for by not investing in promising companies? Waiting for lower valuations? Weeding out the riff-raff?
In a nutshell, not losing money. Sometimes doing nothing has a higher expected payoff than doing something. Even promising companies are vulnerable to a financial crisis of this severity.
It seems pretty clear that public companies (with recent IPOs especially) are most affected; seed stage the least. Raising a seed or A round really shouldn't be any different (the sums involved are smallish for the funds, even with multiple investments and reserves), but it's entirely possible it will be (or, that it will be used as an excuse).
I'm going to hypothesize that the push to cloud, and need for improved computer security, is a much much stronger positive trend than the current economic issues. I'd be more concerned if I were a B or IPO stage company which relied on local/state/federal government sales (e.g. some kind of government-optimized CRM), or maybe an expensive consumer product. Genuine luxury seems like it should do ok, especially non-deferrable luxury servies, but "aspirational luxury" for middle class and lower class might suck. However, really cheap entertainment might win, too -- much better to be video games than movies in a downturn.
Surely public companies have no need to care that much? Once your shares are sold, they're out there, you don't care all that much if they decline in value.
The people for whom this is really bad news are the companies who were planning an IPO in the near-to-mid-term future.
1) "Fiduciary duty" in 2011 in the USA seems to mean maximizing share price at all times. If you don't, you're out of a job.
2) Compensation is largely tied to stock price -- either via options, or via bonuses paid explicitly on stock price.
One thing you can do is bury your own specific bad news in a general downturn, since you'll be blamed a lot less for external things. E.g. if you have recalls, bad numbers, etc. to announce, announce them on a day when everyone is getting hammered for exogenous reasons.
But yes, definitely worse for companies who have registered but not completed IPOs.
Point 3) is that it is nice to keep the stock price high if you need to do an additional offering down the road.
This is probably the only real reason why a company should care about its stock price. Tying executive compensation to the stock price encourages the company to think on a quarterly basis. I don't think this is good in the long term.
Nitpick: much better to be _small_ video games. The big ones easily push into the same financial territory (for making them) as movies, and have way less avenues to monetize afterwards. (No "DVD sales", no money from the rental market, no TV deals...)
Sushi is $100 an hour? Where do you go for Sushi? I've been several times to an _excellent_ Sushi bar, in Los Angeles, and the worst damage I ever did was $75. And that was really trying for it. (Sidenote: gold flakes on Sushi don't add in any way to the taste, but they sure look shiny ;)
While I think Mark's article is insightful about macro issues, I have a different perspective on how VC firms should react. I will never forget the partner meetings we had when the bubble collapsed in 2000. The lessons of the years that followed immediately after the collapse always stuck with me. First of all, we are long term investors (VCs as a whole). I saw numbers recently that the average time from Series A to exit was up to 8 years. Managing through that entire lifetime means that a Series A investor that is looking at the public markets is looking in the wrong place. What the public markets are going to be doing in 8 years is the real question, and it is an unanswerable one. So we all have to build companies, real companies. An exit should be a pleasant interruption of the process of building a company. Building a company means planning for good times and bad (as a company and as a funder), not having to suddenly panic because the stock market went down. The only companies in my portfolio that need to react quickly are those in registration for IPO or in discussions with public acquirers whose stock prices just dropped.
Otherwise, it's steady as she goes.
One note I will make though, is that VC valuations do seem to track (irrationally) the public markets. After a crash is often a good time to invest, particularly if other funds do pull back, and competition is diminished.
I agree, an excellent article. The main thrust, though, seems to be
"This is a terrible time to start any business exposed in any way to US
retail. We won't have sane economic policy until at least the 2012
elections."
My message to entrepreneurs has been, “It’s coming soon to a theater
near you.” You know – the “butterfly effect” on a local and tangible
basis. Consumers hurting in Detroit or Biloxi will not continue to
spend money they don’t have and income they’re not earning. It will
impact retail. It will impact brands. These companies advertise. On
your tech platforms. These consumers buy iPads, iPhones,
Androids. You’re counting on them for up-sells to your app. For buying
virtual goods. You need consumers – they’re 70% of the economy.
Trouble is – they don’t have jobs. Those that do still have too much
debt. Their 401k ain’t what it once was and it just got whacked
again. They still have too much personal debt. And the equity in their
house isn’t rising. They’re doing what economists call
“de-leveraging,” which means spending less, saving more.
************************************************************************
Maybe the stock market drop will bring some clarity to congress. Maybe
it will bring some bi-partisan spirit to solving the nations
problems. Maybe. But evidence seems to the contrary. Right now people
seem to be angling more around November 2012. And that sure sounds a
long way away to me.
I don't think he's saying 2012 will bring sane policy - he's saying that people are hoping the 2012 election will break the gridlock on policy.
Maybe sane economic policy will win out, maybe it won't. (In my opinion, either way: the reduction in uncertainty is likely to improve the investment environment)
Though this post is great it makes me worry the tech sector has learned nothing from the past. If you're worried about the stock market and the climate for IPOs and acquisitions you've failed to learn the lessons from the 2000 bust.
Quick refresher: After the first, big dot-com bubble burst a new ethos based on its lessons spread and came to dominate biztech thinking for at least several years. It emphasized slow, organic growth; revenues exceeding expenses from almost the very start of a business; and a bootstrap self reliance that said you pay for growth from income, personal debt (credit cards) and maybe some very trusted seeders (friends and family). Think Joel Spolsky, 37signals, Paul Graham. This was the start of the deprecation of VC.
People were receptive to this message not only because VC was discredited and largely AWOL, and because so many revenueless VC backed companies had blown up, and because Spolsky Fried and Graham were such articulate writers, but also because servers and bandwidth and hosting services got so cheap in the early aughts. You didn't need VC to get up and running on a Sun with Netscape Enterprise Server any more; you could conceivably launch with a VPS running a free LAMP stack for $100 month or less.
It seems to me a lot of this very sensible, fundamentals-oriented thinking has been lost in the last several years. You still see a lot more bootstraping than in the first boom, don't get me wrong, but you also companies taking loads of VC to stay afloat, before they have a real revenue source, just like in the bad old days. The biggest companies doing this would be Twitter and Foursquare but there are loads more smaller ones beneath them in the same boat obviously. Even Spolsky who partly made his name railing against dot com era VCs (e.g. http://www.joelonsoftware.com/articles/VC.html) took VC for Stack Exchange, a startup without much revenue (though the tech and user experience is superb and the whole Careers 2.0 thing could produce some very solid revenue some day).
All of this is a long way of saying, if VCs had been investing in the 2001 style all along -- companies with a demonstrably viable business plan; with real, substantial and growing revenue streams; and with a specific identified use for the capital invested, with plausible scenario for how it would be returned to investors (not IPO/acquisition lottery) -- they would have no reason to worry about the public market because the model for return on their investment would have to do with the income of the company and not the existence of lots of Greater Fools in the stock and M&A markets.
This was my first notion too, but I think if you look more closely as Suster's arguments, he is really pointing out disparity between 2 forces:
1. The short-term economy (including stock markets, jobs, growth and politics)
2. The long-term (10-yr) tech investment opportunity
So, he is saying "we know the returns are there over 10 years, but we've got to survive in the meantime". Equity markets aside, the fundamentals of business are effected by the short-term economy.
I kept wondering too, is this true for private investment (ie, angels)? Are they susceptible to the same short-term concerns? Or will Angels keep pumping money into early stage independent of the economic conditions? Perhaps this post is doing nothing more than pointing out the obsolescence of the VC model through uncertain economic conditions..
It's definitely possible that the "fundamentals of business are effected by the short-term economy." Good point. I just didn't see that point being established in the VC post, at least not well. It seemed much more focused on opportunities in equities. Maybe I need to read it more closely.
It just seems to me that if you a product that can produce the sort of returns VCs are interested in, it should be valuable enough to customers that it could do well in virtually any macroeconomy. Google, for example, launched its cash cow AdWords just after the first dot-com meltdown.
> I kept wondering too, is this true for private investment (ie, angels)? Are they susceptible to the same short-term concerns? Or will Angels keep pumping money into early stage independent of the economic conditions?
Economic conditions have a huge effect on the number of angels.
For example, the dot-bomb killed a lot of angels. So did the 2008 crash. The run-up this year created some.
The actual asset correlation between the tech sector ( say the XLF spider ) and the broad stock market ( say SPY ) over a decent timeline say 1 decade is upwards of 85%.
The rest of your narrative is wishful thinking. Yes, splosky & pg write great essays, bootstrapped slow organic growth may be nicer than fast VC-backed explosive growth etc. But such slow growing startups generally yield slow growing revenue streams. If that's what you want, you are better off parking your assets in a Vanguard etf. The Greater Fools theory may be derisive but it's what propels every twitter, facebook, groupon, yc backed startups, non-yc backed ones and all the ones in between, for the past 20 years and out into the next 20.
Facebook and Google have very real revenues and very strong growth. I have a hard time seeing how you can be correct that they somehow need Greater Fools to "propel" them. Consider: Those companies could produce a very strong return for their investors if the stock market never existed. Because they make loads of profits they could pay out to owners.
Anyway -- Generally, our points are orthogonal. I am talking about the way things Should Be, based on my subjective opinions of what makes for sustainable business growth. I think this boom bust bubble pattern is Bad (capital b to signify squishy concept) for the tech sector. You, on the other hand, are talking about What Is. (Aside from the Google/Facebook misfire.) You have here a four year chart showing tech sector/stock market correlation. I do not dispute that. In fact, my whole point is that maybe not much has changed on the financial side tech industry in the last 10 years. For all the smart people in tech it is still as vulnerable to bubble meltdowns (the crater in your chart) as anyone else. I think that's too bad - tech should be above it.
> PIGS as it is called: Portugal, Italy, Greece & Spain)
Nitpick: initially it was PIIGS for Portugal, Ireland, Italy, Greece and Spain, especially since Ireland got worse much faster than Italy has, and Italy is still on the cusp, as it were.
Even tough I am not directly interested in startups (I enjoy a lifestyle of learning a lot from many consulting jobs) this article is the best article I have read about the economy in a long while.
What is the outcome one could hope for by not investing in promising companies? Waiting for lower valuations? Weeding out the riff-raff?
Is that the best use of a fund's time?
There are going to be good and bad companies no matter what the rest of the economy looks like. Figure out your thesis and stick to it when you invest. But don't just sit there.