Venture Capitalists typically have partners’ meetings on Mondays. Why is that? Who knows. But probably because as a group we travel a lot. So the industry formed around a day of the week when all partners could avoid having company board meetings or traveling.
Yesterday was a Monday. And not a pleasant one.
Rewind. When I first got into the industry it was 2007. Valuations were enormous relative to progress in companies. Web 2.0 was still a term being bandied about. Companies with less than $2 million in revenue were asking for $50-60 million valuations and getting them. My partnership was pretty bearish and scratched our heads a bit at price tags.
It was a great learning time for me. I spent my days meeting companies, figuring out what areas of the market interested me and trying to get a sense for how VCs thought about fair valuations. I thought about things I never had to as an entrepreneur: check size, ownership percentage, deal stage, portfolio construction and risk.
By 2008 I had gotten more serious about championing companies through our investment process. I started showing my partners more deals that I found interesting and doing loads of analysis on the future of markets I thought were ripe for disruption.
I have always believed that TV was ripe for disruption. The parallels to the music industry are too obvious even though the industry players, the medium and the cost structures are different. US TV advertising is $60 billion in its own right. I had found my industry and a deal I really liked in it.
I introduced my partners, we spent weeks with the team and felt good rapport. And just when I thought I had the deal that was worthy of bringing to investment committee the world changed. It was September 2008. The market had tanked. Lehman Brothers had filed for bankruptcy. It was many events that led to the crash but perhaps this was the pin that pricked the market.
The following is a 2-week graph of the end-of-week price of the Dow Jones Industrial Average (DJIA) in Autumn 2008.
And while the market was off 24% in two weeks, it’s worth remember 2 other things
- The market was actually off 40% from its Oct ’07 peak
- The market wouldn’t bottom until Mar ’09. On Mar-6 it hit 6,626 or 53% off its peak
We thought the following:
- No new deals close until we figure out WTF is going on with the market. We need some visibility.
- Let’s review all of our existing investments. Let’s make sure each has enough cash. Cut where needed. Finance where needed. Anyone not going to make it?
- Who has deals in process? Let’s help get their funding get finalized or the company sold if it’s already in play.
- Fawk, man. This is really bad. Depressing. Harrumph.
It felt awful. Kind of like you felt as personal investors, no doubt.
My deal got dragged out and eventually never happened. Mostly we got to see the team operate in stressful times and that changed my perspective on the deal. I need leaders who manage in good times and bad.To build a large company you need to manage through economic cycles.
Come 2009 we felt really bullish about the future for startups because the froth was gone and so, too, were wantrapreneurs. The people left standing had a compelling vision to build companies and we backed many in 2009.
When this period was fresh, in Sept 2009, I wrote a very detailed assessment of what I thought had just happened.
- Companies raised too much money in 2005-08 and had high burn rates
- VCs were very active in this period
- When the market tanked they had the “triage problem” – which portfolio companies to save, which to kill
- So no new deals got done. Everybody focused inwardly
- And VCs scrambled to raise their own funds. Making even less time for new deals
- VCs hate downrounds to even good companies struggled to raise money
- Eventually you have to invest. It’s your job. You don’t get paid to sit on the sidelines. So when the market started showing good signs (iPhone, Facebook, Zynga, Twitter, stock market growth) it was happy days again
- M&A returned. For the same reasons. You would think it would be better for M&A to be more active when the markets are down – better prices. But I guess you could say the same about VC.
- Consumer spending 70% of the economy and vulnerable (wealth effect, build up debts)
- Unemployment likely to rise
- Risks of these two factors to the stock market
- Stock market declines would bring back dog days of VC
The full articles are linked below. If you want a comprehensive summary of the industry in this era it’s worth a read:
In particular part three talked about what happened if we saw a double dip in 2010-11 or a “lost decade.”
We did not. Fundings boomed. 2010 was the year of the “super angel” and 2011 has to date been the year of unbelievably highly priced B,C & D rounds of venture capital. The so-called “billion dollar club.”
Fast forward a year to September 2010 and I wrote my treatise on the 2010 economy. It has some detailed charts you may appreciate if you’re wanting to understand the current economic situation. I show charts on housing, structural unemployment, home equity re-financings that we spent meaning less spending power post crash, new housing sales, debt-to-income ratios, public-sector job problems that will cause crises in cities and states across the US.
Summary version? No chart was good.
At least you can’t accuse me of being inconsistent. My year-over-year summary sounds very similar upon re-reading them.
I have a young entrepreneur friend who IMs me a lot. He was working on a VC round in the early Summer. He pinged me for advice. I told him (verbatim), “close your round by August 2nd. After that, all bets are off.” He’s literally on IM right now in my other browser tab saying, “you called it.” I can’t say his name yet because he hasn’t announced funding. But he got it done. Maybe he’ll reveal our conversation when he announced.
August 2011. What’s happening?
The fundamentals in our economy are mostly not on more solid footing than when I wrote the posts in 2009 and 2010. On the positive side, corporate profits are up, their balance sheets have been repaired and they have recapitalized themselves to have lower amounts of debt relative to equity. Not just tech companies but industrials, too.
But you’d have to be a pretty heads-down coder to not have noticed the past 2+ weeks in the DJIA.
Most of the informed people I know are telling me that the sharp sell-off has more to do with European national debt (PIGS as it is called: Portugal, Italy, Greece & Spain) than the current US dilemma of a S&P downgrade of the US government debt. But it must also be on the minds of investors that perhaps the flu will end up on our shores, too.
I know that investors must also be aware of the civil unrest in the UK. Yes, it seems to largely be thugs. But social unrest is created in harsh economic times and we’ve seen this in Greece before. Expect it to spread. It does weigh on the mind.
And while I cannot tell you for sure what was going on in VC partner meetings across the world today – I’m a data point of exactly one – I think I have a pretty informed guess. And depending on which way that economy heads I can tell you what the story in entrepreneur land *might* be in 60 days, “funding is getting harder, valuations are slipping, companies are running out of cash, M&A is slowing down.”
So let me give you the news 2 months early. If the economy and the stock market continue to languish that’s exactly what’s going to happen.
I’ll bet most partners’ meetings this week consisted of looking just a little bit closer at the cash needs of their portfolio companies – making sure they’re “fully funded.” I’ll bet many of them did a review of their “investment pace” as in – how quickly should we be investing. I’ll bet many did a slow roll on deals that might have gotten approved today. Not a “no” but not yet a “yes.”
It’s impossible to sit in a partners’ meeting on a day like today without having an iPhone on watching the stock market free fall and no matter how much of a public tech cheerleader you are – privately I guarantee there was much concern.
If we do head South it will take a few weeks or months until the memos to portfolio companies get published and the Powerpoint presentations get sent out. But the internal conversation started today – trust me. VCs will take a “wait and see” approach right now. Don’t want to call it either way. It’s too early.
Me? I feel confident telling you to, “Watch your pennies. Raise your money. Don’t spend like it’s 1999. If we’re not heading for a double dip recession at least you’re still being prudent.”
Maybe we’ll bounce right back? Anybody who says they know for sure one way or the other is a bit of a shaman. But I have to imagine the speed and severity of the stock market decline and political instability will likely weigh on investors for some time to come – even if we rebound.
[Update: I wrote this post for TC yesterday. Obviously the market rallied today on news from the Fed. I'll cover this in my next post. Hopefully tomorrow. Here's the graph for the books.]
I’ll tell you what still worries me: Jobs, growth & political malaise. And don’t think tech will remain immune.
I guess that’s why I encouraged people to raise money while the getting’s good (PPT slides & video).
I’ve been parroting this for 2 years. We have a two-track economy. We have the inability to hire engineering in Silicon Valley or brand sales people in NYC but the country still has very high structural long-term unemployment. Check out the graph below from the Economist magazine. It plots employment changes from the peak GDP quarter of the previous boom. What you’ll see is that it takes about 2 years to recover jobs from the normal recessions of the past 50 years (as if there was a “normal.”)
This recession? We’re 2.5 years in and still down 5% from the peak.
What gives? I’m guessing many of these jobs ain’t coming back any time soon. The last big recession was in the early 90′s where IT and globalization were in their infancy in terms of impact. We need a plan to replace these jobs long term. That can only come through education, training and investment in regions of the country that are not IT centers. There’s no band-aid solution and no quick fix.
Whatever you think about tax policy, I’m certain that it’s not driver one way or the other to fixing this problem. Anyone who says it is a driver is selling you political malarky.
We gotta fix jobs.
The story here is no different.
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.
And you don’t see it. You don’t see it because the world you likely live in if you’re reading this has been booming. And even if you’re not physically in a booming tech market you’re likely in the market spiritually, metaphorically. You’re reading TechCrunch, aren’t you?
3. Political Malaise
I think here I’ll just quote myself from my analysis a year ago to avoid sounding like I’m jumping on the bandwagon of this week’s quarterback analysis:
“While there was a momentary unity in the US government for bailouts & stimulus spending that were initiated in the Bush administration (many people conveniently forget this now) and continued under Obama, it is clear that this era of consensus is over. Keynesians will argue that this is a bad thing and fiscal conservatives will argue that it is a necessary discipline.
Either way, the gridlock that is now the US congress will prevent any real economic responses and it seems likely that this political malaise will last beyond the 2012 election as the Republicans look to make big gains in the 2010 mid-term elections.”
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.
What does this mean for the tech and VC markets?
I’m characteristically still bullish on our long-term trends for companies who get through the toughest times. Here’s what I know:
- Television will be consumed dramatically differently in 10 years from now than it is today. Creative destruction will continue to create opportunities for people who understand the deflationary economics of the Internet. I’m long.
- Cash will continue to become less relevant in 10 years as electronic & mobile commerce continue to proliferate and new technologies like NFC drive change. I’m long on payment technologies.
- Computing will be an order of magnitude more mobile 10 years from now, changing the way applications are delivered and the way we interact with our real social networks. I’m long Mobile. And Social.
- Businesses will continue to realize that the Internet is one big information utility and will continue to move operations to the cloud. This will create whole new segments of the tech market for databases, data-as-a-service, real-time information processing, cloud mapping & visualization technology, etc. I’m long the cloud.
Venture capital is an industry best served up from 7-year aged casks. As many people have said, “We over-estimate the impact of technology in 3 years and under-estimate the impact in 10 years.”
Make sure you’re still here in 10 years. Get yours. Then go build your companies.
Top image courtesy of Fotolia.
(Cross-posted @ Both Sides of the Table)