Guest author Chad Riddersen, an investment banker–turned–growth hacker, co-founded Deviate Labs, a growth hacking consulting agency, in 2014 to help scale both startups and traditional businesses.
All summer long, prominent early stage investors like Mark Suster and Fred Wilson have been cautioning against Unicorn valuations and California capitalism where, as Maciej Ceglowski remarks, “investing has become the genteel occupation of our gentry.”
Now that we are entering fall, you can feel a crisp in the air … fellow frogs, can you sense that winter is coming?
Alas, our fairy-tale valuations are being confronted with public market pragmatism, and the time has come for us frogs to seek shelter, so we can survive winter’s liquidity freeze.
Come All Ye Frogs
Most of us in Startupland prefer to live in silicon-monikered startup bubbles like Silicon Valley, Silicon Beach, and Silicon Alley. In our attempt to do the impossible, we gravitate to ponds of like-minded people conveniently located next to venture capital well-springs where 100-hour work weeks and multi-million dollar financings are the norm.
While the benefits of our entrepreneurial micro-communities are aplenty, we inadvertently create insulated echo-chambers where signals ricochet loudly off the walls of our bubble resulting in the signals themselves becoming the noise.
We’ve seen freshly minted MBAs saddled with $200,000 of debt forgo the classic cash-rich industries like consulting and investment banking in pursuit of startup riches. We’ve seen doe-eyed grads garnering riches greater than both their parents combined.
So numerous are the frogs in Startupland baptized post-2008 that we ignore the ones that have survived winter before. But as more naïve frogs spring into this pond, seasoned investors croak the inevitable warning of a change in seasons.
This time last year Alex Wilhelm published an article on TechCrunch titled “Winter Is (Probably) Coming (Soon),” in which he quotes Bill Gurley stating, “I do think there is a high likelihood that we’ll see some high-profile failures in the next year or two.”
Well folks, we are in year two, and the macroeconomic forewarnings made in that article are true now more than ever—except this time, there’s one big factor that Startupland has conveniently dismissed. And that could expose us frogs to frigid winter elements killing everyone that fails to hole up before first frost.
China’s Impact On Startupland
When an atomic economic bomb erupted in China this summer, we paused for a moment to see if the aftershock would hit us. But when nothing happened, we lurched forward feeling a stronger sense of safety in our bubbling startup bubbles.
But when more than $1 trillion of value evaporates from the global economy, can we be so naïve to think that this will not impact us?? To put it in terms that Startupland will understand, the Chinese economy lost the value of all our beloved Unicorns combined—or put another way, if you added up all the capital VC funds raised in the last decade, you still would only be a quarter of the way to the value lost in China this past summer.
China will have an impact on Startupland.
In an attempt to tourniquet the economic bleeding, the Chinese government began to buy up its currency and backstop its equity market, among other things. The bailout efforts racked up a bill of about a quarter trillion dollars as of September 2015. These efforts require truckloads of cash, and China, the largest holder of U.S. debt, has offloaded $100+ billion of U.S. Treasuries.
What’s a startup frog supposed to make of all this macroeconomic stuff?
A reduced demand in U.S. treasuries will make it more expensive for the U.S. to borrow money, leading to a rise in interest rates. That will make other asset classes more compelling to the big institutional funds, like pension funds and sovereign wealth funds, that feed the VC ecosystem (i.e. big institutional funds will not have to allocate as much money to venture capital funds in order to get the risk-adjusted returns they seek).
Less money flowing into venture capital funds will likely delay and reduce the number of vintages dedicated for late-stage and follow-on investments. Ultimately, that late-stage capital scarcity may lead to the death of a high-profile unicorn (as many unicorns have massive cash needs and anemic revenues).
The death of a high-profile unicorn would get mountains of press and make early-stage VCs sit on their hands.
The outcome: the popping of the startup bubble.
At that point, the tender young frogs with their freshly minted MBAs would go hopping back to investment banking and consulting to pay-off their debts, and naïve computer science grads would have to make-do with more modest, sub-six figure salaries. Meanwhile, the talent pool would see dev teams across the land jettisoning from dying unicorns.
Mark Your Calendars For 2016
If you assume the more aggressive unicorns are saddled up with 12-18 months of cash runway, you can expect the first unicorn to starve and die in the summer of 2016. After that, it will probably take a quarter for Startupland to realize that it wasn’t an anomaly (which will be proven by another high-profile unicorn death).
So, by the fall of 2016 this should be played out.
As with most predictive analysis, estimates pertaining to timing are a concoction of intuition and qualitative assessment. The predictive quantitative metric to watch out for is the quarterly VC fundraising report by National Venture Capital Association (NVCA) and Thomson Reuters. One would expect to see a dip in the fundraising (relative to the same period the prior year) as a warning shot for Startupland.
That warning shot showed up on October 7, 2015: The NVCA and Thomas Reuters reported that Q3 fundraisings were 33% less than Q3 2014.
Pundits like Bobby Franklin, the president and CEO of NVCA (the organization that did the fundraising research), ignore the warning shot. Instead, they point to the total equity investments into venture-backed companies published in the quarterly MoneyTree report by NVCA and PwC saying, “With seven consecutive quarters of more than $10 billion deployed to the startup ecosystem and more than half of all investment deals now going to seed or early stage companies, it’s a great time to be an entrepreneur in America.”
Fundraising is a leading indicator. Deployed investment is a lagging indicator! As the saying goes: You can’t drive forward looking through the rear-view mirror.
In a dotcom deja vu-inducing statement, Tom Ciccolella, US venture capital market leader at PwC, stated in the same NVCA press release that “despite a modest downtick in dollars and deals in the third quarter, we are still in a midst of a robust market and this quarter marks the second highest quarter in aggregate investment dollars since the fourth quarter of 2000.”
A Little Frog-Friendly Advice
The writing may be on the wall, but that doesn’t mean you can’t prepare yourself and your company. Below are a few words of advice:
- If you are one of those lucky frogs getting scooped up by an acquisition, don’t be too greedy with your valuation expectations.
- If you’re planning on raising capital in the next 12 months, start now.
- Go through the thought exercise of preparing a profitability plan. The basis: Ask yourself what it would take to run a self-sustaining company.
- Consider releasing products that help people preserve wealth or save money.
- Make sure you are living in Startupland for the right reasons. Think long and hard about the answer to this question: If you make $0 next year, would you still continue on the same path?
Fellow frogs, we must look beyond our Jobsian “reality distortion fields” and assess the world outside our insulated startup bubble. Now is the time to dig deep into the ground.
Winter is coming.