A brief guide for founders trying to survive a market correction
The recent passing of Andy Grove brought to mind the title of his most famous book: “Only the Paranoid Survive.” That title and his message are fitting today, as we appear to be in the midst of a market correction for venture-stage technology companies. Grove might have described this as a strategic inflection point, a movement that challenges businesses to adapt to structural market changes.
It is also nothing new in technology (or any other sector, for that matter). And when moments like this occur, the usual suspects—VCs like me, pundits, others—emerge from the woodwork with opinions. I haven’t seen “cash is king” yet, but I am certain that’s been in several VC emails to their portfolio CEOs.
I’ve lived, as a VC investor since 1992, through three significant corrections: ’99-’01, ’08-’09, and (I think) the present. Here are my five easy pieces to help founders stay paranoid:
1. The worst is yet to come. Charles Kindleberger wrote the authoritative book on bubbles (Manias, Panics and Crashes) in 1978. Republished in 2011, the latest edition includes the 2000 dot-com crash and the Lehman-induced meltdown of 2008. The main lesson: market corrections are a “hardy perennial."
There is a point at which “rational exuberance morphs into irrational exuberance,” and investors and investees get ahead of themselves. In this tech investment market, that probably began at least three, perhaps five years ago. And as usual there has since been a pervasive sense that this time things will be different.
Of course they won’t. You can hope for the best, but if this period is anything like prior downturns, the worst still lies ahead. This is especially worth noting right now because over the last three months equity markets have rebounded. But that unfortunately doesn’t change the fact that there is widespread irrational exuberance.
Hope is not a strategy. Market bubbles always implode. Kindleberger describes the stage that immediately precedes this implosion as a mania: a non-sustainable pattern of cash flows builds up because everyone wants a piece of the action. Soon all kinds of new participants with no prior history of participation start entering the funding environment because they want in on the gold rush.
It is only a matter of time before a mania overextends itself, leading to the next phase of a crisis: distress and panic. Both Kindleberger and Grove talk about the same behavior here (the former uses the word “distress,” and the latter “paranoia”). My advice—and this is always easier said than done—is to be paranoid before it is too late. You want to be grounded at least one iteration before the economy at large, and in doing so remain in business for the long run.
In fact, I would say you want to be paranoid all the time (indeed that is Grove's fundamental point). Make it the way you do business, not just the way you react to market corrections.
2. Downgrade the swagger. Treat this as an opportunity. Get rid of the fat. Sublease that swanky office. Decimate the perks. No, it won’t affect morale. In fact I would argue that there is something laudable about such conduct that should boost morale. As long as your (carefully selected) employees are on the same wavelength, hard work and humility are naturally preferable to extravagance.
If you have employees showing up because they want the high-end coffee machine—well, those are not the employees you want. You’ve been agonizing about culture? I’m sure you’d rather have a culture of excellence and performance, than a culture of Friday afternoon happy hour with single malts. Also: no hipsters allowed. You don’t need court jesters in the office when you are fighting to survive and thrive.
In a competitive labor market, it is easy to fall into the trap of trying to keep up with the Joneses, in the form of much larger and much more profitable competitors for talent. Google, for example, has a rather famous canteen on a huge campus on which employees zip around in razor scooters. But Google throws off more than ten billion dollars in cash every year -- you don't. You want to learn from Google's ability to instil a productive and innovative culture—not from its ability to afford an extravagant one.
3. Increase your focus on capital efficiency. Stop buying revenue with no concern for cost. Manias end up being massive “emperor has no clothes” moments. Eventually both founders and investors will register that negative gross margins, as an example from today’s sharing economy startup explosion, simply do not make any business sense. If you’re in the SaaS business, to pick another example, stop talking about MRR/ARR metrics with no melding of how you’re spending to get to those metrics.
Sean Jacobson, a partner at Norwest, provides some examples for focusing on capital efficiency in his blog. One excellent point is to not "splurge on sales and marketing” when you don’t fully understand your business model. The example of WageWorks, a company that administers pre-tax benefits, is insightful. As a startup, WageWorks focused on being a “tax policy expert” rather than marketing itself, allowing the company to acquire major clients such as Ernst & Young and Bank of America without building a large and expensive sales force.
If I were to pick one piece of advice, it is this: these are great times to focus on your product (or innovate around new products). It’s almost always the right thing to do for your business, and cost control is just a laudable side effect.
4. Get innovative about your business approaches. There are so many examples here, and I’ll throw out three:
· It is not necessary for all of your employees to be working from the same office. It really isn’t. And you don’t need to look far; Amasia, the firm I chair, has one portfolio company that may build out a dev team in a college town in Southern California. Lots of companies—big and small—are taking advantage of virtual communication and technology by letting their employees work from anywhere around the globe.
· Double down on partnerships and alliances, where the cost of sales is moved off your P&L/balance sheet. You’re giving up margin? Sure, but what’s left is pure margin—and doesn’t have to be forever.
· This is a great time to explore global markets. That sounds counterintuitive, but it’s an area where you can experiment with multiple locations and partnerships in ways that expand your market while keeping costs under control. Your international partners can save you R&D and implementation costs through their knowledge of and presence in these global markets.
5. This too shall pass—but you have to be around to reap the benefits. Some of the most iconic technology businesses of our time were built precisely during the ’99-’01 period. You know their names. They survived and thrived because their CEOs followed these and other lessons, and built fundamentally better businesses as a result.
For the best companies, these times often result in the creation of new growth vectors. Amazon, for example, saw its stock drop from over $100 to $7 a share in 2001. The company ran lean and mean, never ceased to innovate, and here we are now. Kindle, Amazon Web Services and Amazon Prime are all giant businesses in their own right.
Kindleberger provides a nice analogy to describe times like these. Market corrections, he says, resemble a child cycling down a slope and eventually losing control. To prevent ourselves from crashing, we ought to cultivate a healthy dose of paranoia—and apply the brakes in time so we can coast smoothly onto level ground.
Nothing I've said here should be misinterpreted as pessimism. Paranoia can and should be converted into positive energy, allowing for more innovation, excellence and productivity.
If you have advice for me, or just want to share an opinion, please feel free to leave a comment in the comments section below.