when a technology startup, its investors or the market believe in robust growth rates writ large
“the ecommerce company gained fauxmentum by raising artificially high amounts of venture capital and spent lavishly on customer acquisition despite long payback periods and questionable LTV”
We live in heady times. Startup companies continue to grow at unprecedented rates, raise enormous amounts of venture capital and achieve valuations that imply that they will continue to grow rapidly for the foreseeable future.
We can see in the market the telltale signs of a rapidly expanding market: wage inflation, high staff turn-over, rapidly increasing rents with scarcity of space and booming real estate market with prices and rents for homes unaffordable for many. I don’t meet many rational invests (VCs or LPs) who believe this will last but of course nobody knows whether we have 6 weeks, 6 months or 2 years.
A certain amount of the growth in today’s market is genuinely caused by the economic leaps that globally connected markets, widely available smart phones and frictionless commerce caused by the linking of our credit cards, bank accounts or crypto currencies to our phones for 1-click purchasing. On the other hand a certain amount of growth is fauxmentum caused by the over-funding of the startup markets and ebullient buyers of technology products (both businesses and consumers).
When the music does stop playing it will create a more jarring counter force than you feel when markets grow more sensibly. But can sensible management team even do anything about it? Rational investors can’t sit out of the market entirely so what can they do?
Let me give you some examples I see of fauxmentum:
In the SaaS world I see many business plans where companies have achieved 100-300% year-over-year growth and this is truly impressive. My cautionary tale here is that we’re in the phase of the market where every corporate buyer of software is being paid to innovate. Their bosses are literally encouraging them to work with the latest startups, install new collaboration tools, build apps, integrate with APIs and so forth.
We’ve been here before and it feels familiar. Many startups, though, don’t have the muscle memory to know the signs of when this changes gears and may believe good times are here to stay. But when economic conditions turn nobody is paid to innovate: They are paid to cut costs, cancel projects, reduce staff, do more with less, stop attending conferences and improve the bottom line.
So those bullish pipelines your teams have developed that may be completely real in this market environment but at some point will stop materializing. 3-month purchasing cycles will turn into 9-month cycles and the pace of growth will naturally slow – even for great companies that have amazing products.
I’m not saying don’t hire sales staff or market your products aggressively. I’m not saying you shouldn’t grow engineering or do PR. I’m saying something simpler:
- protect your balance sheet and make sure you have enough cash to weather a slowdown and don’t let your reserves dip too low before raising more capital unless you have no choice
- get out and raise money now because when markets change they change on a dime and capital completely dries
- limit your fixed costs. In a rapid correction we can call cut excess jobs, slow marketing spend, travel more sensibly and attend fewer events but high fixed costs kill many companies in recessions
- at least be thoughtful about what is the right growth rate for your business and always ask yourself the hard questions. Push yourself harder to be sure that your product is truly solving a deep problem for your customers because in a recession fauxmentum is the fastest thing to grind to a halt
In the ecommerce arena I see some great companies spending heavily on customer acquisition. When customers are buying your products like hotcakes it can be intoxicating. Sometimes this is legitimate because your product is simply awesome. But even awesome products can slow when consumers feel the negative effects of a reduction in their personal “wealth effect.” Sensible companies are careful about inventory levels, material commitments and so forth.
I also see many ecommerce companies that look less sustainable to me where they are spending on growth in excess of healthy levels and sometimes they have really low gross margins that will make it hard for them to recover their customer acquisition costs (CAC).
There are both entrepreneurs and some investors who focus too much on top-line revenue at the expense of gross margins, payback periods and CAC and because funding has been freely available to those that show growth many are encouraged to continue with growth for growth’s sake.
I see another breed of startups who are dependent on startups for the majority of their revenue. I am most skeptical about this class of startup because they are simply way too vulnerable to a correction in our market. I always encourage startups to seek a healthy balance of corporate revenue to balance their startup-company revenue. When you’re a startup it’s often easier to sell to other startups because they are: like-minded, tech-savvy, less sophisticated in procurement rules and loaded with cheap capital.
But as with any sales advice, revenue diversity matters. Concentrate your revenue on only startups at your peril. I’d rather grow more slowly than to have all of my eggs in one concentrated basket of any customer type.
There are many types of fauxmentum and some of it will naturally come to even healthy and well-run businesses that are the recipients of the spoils of a growth market.
Make sure you have long-term planning sessions where you have all sorts of “what if” conversations. Keep your fixed costs as low as possible and know what you’ll do if the tides turn. Be prepared with your contingency plans if the market conditions change because when they do so, they do it quickly.
Raise capital when you can and raise slightly more than you need. Try to keep a reserve that you don’t spend. I’m not talking about raising 10x what you need (that leads to a lack of discipline) but perhaps an addition 6 months more than you need. Or a year.
Growth at all costs sometimes pays off if you time the market perfectly because investors step in to fuel your losses. On the other hand sometimes companies are caught between market shifts. Make sure that you at least understand the risks you’re taking on if you want to grow at all costs.
(Cross-posted @ Both Sides of the Table)