If you didn’t notice that the stock markets in the US dropped nearly 4% yesterday (after falling last Thursday and Friday) then you were probably completely off-the-grid and on vacation.
It was a nerve racking morning.
My favorite Tweet of the morning came from Hunter Walk
You thought media twitter was bad… You thought tech twitter was bad….
— Hunter Walk (@hunterwalk) August 24, 2015
And by this I assume he meant that “market prognosticator twitter” was vomitous. And if that’s what he meant he was right. I saw a few friends politely suggesting that “now was a great stock buying opportunity” meaning that given the stock market is off by 10% it was a great chance to buy and lock in presumably low prices before the market rises again.
I’m not so sure.
And I said so publicly. I said nothing more than I thought people should be cautious because it times like these it’s hard to know how much market panic could ensue, what the knock-on effects would be and whether the market could fall further. It’s also hard to know (unless you’re a professional trader at a large fund with tons of research and colleagues who have more market knowledge than the average retail investor) whether the market is off of a fair value by 10% or whether it was already 20% overvalued and this is an inevitable correction.
That’s the thing. Unless you’re doing this as your career you shouldn’t be dipping in-and-out of anything. I’ve seen friends (and family members) lose much of their savings that way over the years because “Black Swans” happen and in 1987, 2001, 2003 & 2008 (just to name a few from my memory) huge market gyrations caused much financial distress to people seeking short-term gains.
The most interesting phenomenon was how quickly some Twitterers were to attack me for suggesting caution. They reminded me that the market is now higher than 2008 when it crashed (note: it’s also higher than it was in 1968, 1988 and 2003 – all of these are irrelevant). Simply put – I buy the long-term case for having a portion of one’s savings in stocks. I caution people from thinking this is necessarily a bottom. You don’t have a clue. Neither do I.
But I do have some insight into how this will affect venture markets.
1. The immediate impact is a longer funding cycle for anything but seed and A rounds
I made my calls around to a few firms today to hear how their partner meetings went. The consensus view is that many firms are taking a “wait and see” approach. That means specifically they’re not sure if this is a normal & slight correction or the start of a new cycle. So why invest in that period of uncertainty unless it’s early-stage and thus valuation matters less. If the next 30 days stays calm then investment will pick up. If markets continue to drop expect fund-raising timeframes to elongate. So plan your start date accordingly. You might also favor a quicker close at a slightly lower valuation than you had hoped in order to decrease risk. Up to you – that’s how I would be thinking.
If you think that public market valuations have NO impact on private market fundings you’re fooling yourself. For starters – we all know the argument that more enterprises are buying SaaS software because it works more easily than on-premise software and that expectations set by our consumer lives to have software as easy and convenient as Amazon, Google or Facebook drives our business lives.
So, too, investments. When many venture investors are seeing their personal public portfolios tank it creeps into their business lives and creates an emotion that is less risk tolerant whether they’re aware of it or not. If you want to understand the shortcuts we take in this kind of decision making check out this book by nobel prize winner Daniel Kahneman.
If markets come back quickly then you’ll see a return to normal 2015 funding timeframes (which I can tell you are much quicker than in times past).
One thing you should know if you don’t have a background in economics or follow financial markets. The two big dates everybody is holding their breath for are Sept 16-17 and Oct 27-28 with an emphasis on the former. These are the next two meetings of the Federal Open Market Committee (FOMC) where Janet Yellen will give guidance on interest rates. Conventional wisdom amongst my investor friends is that if the Fed raised interest rates by 0.5% you would see a sell off in the market. But that was before this week. Now I don’t know what to think. If we leave interest rates it can be interpreted as a fear our economy will be weak and/or impacted by China. If she raised them then the interest rate bears may weigh in.
The truth is that I don’t know how the markets will perceive her actions. But I do know the world will be watching so I’m personally feeling cautious until I see how that all plays out. I’m not saying I’m not investing – just that I’m generally aware that the market does drive venture capital fundings and I’m very interested to see how September plays out. I have to assume other investors feel the way I do. At least later stage investors.
2. This could have an impact on later-stage valuations. Some evidence is already present
The one thing that has become clear to me over the last couple of months is the skepticism that many late-stage VCs (and LPs) have had about late-stage valuations. Everybody has the “feel good” effect of massive mark-ups on their private portfolios because deals have been massively marked up by late-stage investors. But many of these (75% in the case of unicorns) are not led by traditional VCs.
As a result I’ve heard many growth-round VCs tell me that market prices are starting to compress for rational investors. They see public market comps and know that one day they must exit their investment and they’ll be judged by these public market comps so it’s creeping back into how they value late-stage deals.
If the markets fall this will become pervasive. If they hold flat it’s possible the VCs will stay price-neutral while many non-VCs will pay up. If markets bounce to the positive it’s possible that we’ll stay frothy for a while (although I would bet against that). One thing I’m 100% sure of – the outcome of what happens will be highly correlated with public market movements in the next few months.
3. This could impact VCs
If markets do tumble this will impact VCs in several ways. It will make follow-on financings much harder and people will have to consider whether or not to do inside rounds. It will also mean a certain amount of triage and also some mortality rates amongst investments. These are all normal things but in this big run since 2009 we’ve all gotten used to nearly 100% follow-on financing rates, valuations only moving up, deals clearly the convertible note caps and low mortality rates.
If market slumps persist the woes will extend into LPs who will take a wait-and-see approach to investing in VC funds making 2016 an unpleasant year to be raising. The impact hits VCs in an immediate way that most entrepreneurs don’t realize. Our investors often allocate across different classes (real estate, commodities, public stocks, bonds and private equity – of which VC is a subset). When publics drop (and with it often commodities) they have a “denominator problem” meaning that if my total position in assets that are valued on a real-time basis (like stocks) goes down by 20% then I’m now over-indexed in assets whose value doesn’t immediately change (like venture).
So with my portfolio out of whack I need to be cautious about not overly committing to venture funds so I scale back until my denominator is fixed. This doesn’t happen with every LP and it probably doesn’t kick in unless things get worse. But I can tell you from first-hand experience it was a real issue in 2008-2009 and the psychology persisted into 2010-11.
4. Watch the market closely
So I’ll come full circle. I’m in the “don’t panic” camp. Don’t rush to buy stocks personally thinking that now is “cheap” because … who the fuck knows. If you didn’t even know the FOMC was an anticipated date mid-Sept then consider what else you don’t know. I know what I don’t know. Which is why I’m not a big public stock picker.
The reason to watch the market is that it impacts you. If you’re an entrepreneur and the markets continue to drop steadily over the next 30 days please ignore any advice that this doesn’t impact you – it does. Be aware of your fund-raising calendar and timeframes and keep valuations relative to times-to-raise in mind. If you’re cashflow positive – the markets still affect you. They affect consumer spending. They affect business spending. I’ve written about fauxmentum before.
One final note
I know that the fact that I’m talking openly about how public markets affect venture will mean people will interpret me as overly bearish. That’s not the point I’m trying to make. I’m trying to make the point that we don’t live in a vacuum and the sooner you realize that the sooner you’ll be prepared if anything changes. For anybody whose only been an entrepreneur (or VC) since 2009 it would be easy to think we’re not correlated.
p.s. my normal health warning. I wrote this in one sitting. I didn’t re-read this for typos. I didn’t re-read it to find out where I was wordy. I didn’t re-read it to make sure it makes sense. I’m off to watch Fallon. Can’t wait for Colbert. Miss Jon Stewart. It sure beats proof-reading. I’ll try to sweep the post up a bit in the morning. Bonne nuit.
(Cross-posted @ Both Sides of the Table)