Stock Market Drops. VCs Hold Partner Meetings. What Happens Next?
techcrunch.com
techcrunch.com
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.
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..
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.
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.
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%.
( You can run the exact numbers here, use XLF vs SPY on 10 year http://www.assetcorrelation.com/user/enter_time_corr )
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.
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.
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.
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.
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.
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.
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.
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.
Sushi costs $50-100 for an hour of enjoyment.
A movie costs maybe $15 to see in theater, good for maybe 2h of enjoyment.
A $50 video game might be good for 50h of play. Maybe more.
Netflix is $10/mo for ~unlimited movies.
Excellent article, do yourself a favor and give it a read.
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.
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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.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)
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.
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.
Easy - The bubble pops.