Nivi · February 6th, 2010
… a founder, a VC, and his Associate negotiate a down round. Very NSFW.
Another business lesson from The Wire — about intellectual property: “It ain’t about right, it’s about money.”
“[Recessions] can cause people to think more about the effective use of their assets. In the good times, you can get a bit careless or not focused as much on efficiency. In bad times, you’re forced to see if there is a technology [that will help].”
Water hides the rocks at the bottom of the ocean. Lowering the water level exposes the rocks underneath.
In a great economy, money hides problems and opportunities. Companies will get orders whether or not they innovate. But in a bad economy, lowering the water level will expose new opportunities to our corporations.
Reduced spending will spur businesses to create products that even newly poor customers will buy. Products that customers truly need and value. Products with enduring value.
And businesses will create better ways of designing, manufacturing, marketing, and selling the products customers already buy.
At a minimum, they will learn existing practices they ignored while the water level was high.
Constraints spur creativity. Bad economies demand it. Innovation is easier when the alternative is death.
“The Toyota production system was conceived and its implementation begun soon after World War II. But it did not begin to attract the attention of Japanese industry until the first oil crisis in the fall of 1973. Japanese managers, accustomed to inflation and a high growth rate, were suddenly confronted with zero growth and forced to handle production decreases. It was during this economic emergency that they first noticed the results Toyota was achieving with its relentless pursuit of the elimination of waste. They then began to tackle the problem of introducing the system into their own workplaces… Prior to the oil crisis, when I talked to people about Toyota’s manufacturing technology and production system, I found little interest.”
In 1936 (!), old-school economic giant John Maynard Keynes described the spontaneous optimism that drives startups:
“A large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.
“Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die—though fears of loss may have a basis no more reasonable than hopes of profit had before.
“It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.”
(Via: Mavericks at Work)
In Be Careful Who You Deal With, Matt McCall, a Managing Director at DFJ Portage, has great advice for entrepreneurs who are dealing with “slimy bottom sucker” investors:
“As these markets continue their chaotic path downward, people’s true colors come out. Some people show increasing amounts of fairness and consideration. Others will self-optimize and use every bit of leverage that they can get their hands on.
“Two entrepreneur friends of mine recently had a very negative experience with an investor who has a reputation for being Machiavellian and it really, really has incensed me. These slimy bottom suckers use the changing market conditions to test how low they can retrade an existing deal. Here is the standard game plan for these kinds of assholes. When they sense a dramatic change in the market, they pull away their term sheet siting “policy” changes. However, instead of walking away from the deal, they mention in passing that they might reconsider under “different terms”. If the entrepreneur bites, they know that they have leverage and they proceed to throw down absolutely egregious terms (multiple liquidation preference, half the original price, etc). If the entrepreneur bites on this, they know they really have them and continue to ratchet down the terms until things break and they back off.”
Read the rest of Matt’s post to learn how you can counter this investor’s game with your own game theory.
Machiavellian investors will try this trick in good markets too (I’ve seen it happen). Once you sign a term sheet, the investor will try to retrade terms. By then, you’ve told other prospective investors that you’ve signed a term sheet. It’s hard to go back to them and explain what’s happening. And if you walk away from the signed term sheet, it’s hard to talk to new investors with a blown-up term sheet on your hands.
Of course, Machiavellian entrepreneurs exist too. And VCs have enough “institutional knowledge” to know that. Unfortunately, most entrepreneurs don’t have commensurate knowledge about their counterparts.
(Via Ask the VC.)
“If you want to improve your chances, you should think far more about who you can recruit as a cofounder than the state of the economy. And if you’re worried about threats to the survival of your company, don’t look for them in the news. Look in the mirror.”
“Over the past few months, I’ve witnessed the experts and the media bemoan and belabor the “tough economy.” My attitude in times like these is to stay focused, stay optimistic, ignore the media and operate as normal. We’ve done a great job of doing these at Infusionsoft and it’s paying off. We had our best quarter ever in Q3 and we’re on track to blow that away this quarter…
“Sequoia Capital is well respected. [But] they blew an opportunity to remain optimistic and they succumbed to the fear that’s swirling around. In the process, they spread their negativity to a bunch of smart people who really ought to know better.”
“I guarantee that there are some financings happening right now that are getting done at valuations which would have made sense nine months ago but don’t make sense right now… I also guarantee that there are some financings happening right now that are getting done at valuations at half or even less of what they would have commanded nine months ago, even though the public markets have only gone down about 33% year to date.
“You can look to the public markets for some clues, and everyone I know is doing that, but it will only help so much. We are going to have to make up a lot of this as we go along. But I know one thing for sure. Capital has gotten more expensive in the past month (actually it started getting more expensive late last year) and we all had better reflect that in our plans and strategies.”
This is consistent with my observations and discussions with investors. Investors are looking at the public markets and renegotiating terms or pulling offers altogether. Their argument goes along the lines of “Google is worth less today and therefore so are you.” If you were a smart-ass, you would reply, “We didn’t come up with that valuation, you did.” But that won’t get you far if you don’t have leverage.
“Spend every dollar as if it were your last.”
“A business plan that doesn’t require a wonderful economic environment in order to succeed… is a good idea all the time.”
Summary: In good times and bad, startups should be asking themselves the same questions: (1) What’s our runway? (2) What experiments are we running to extend our runway? (3) How long will we try the experiments before we switch to plan B? and (4) What’s plan B? Startups that survived the last downturn didn’t take life-threatening risks with their runway—survival mattered more than market domination.
(If you don’t see the presentation embedded above, watch it on SlideShare: R.I.P. Good Times)
Sequoia’s presentation offers a lot of good advice with typical insight, simplicity, and clarity. Here are a couple thoughts on their presentation.
Don’t take Sequoia’s (or anyone’s) predictions about the future too seriously. If they’re smart enough to predict the future, they should have done it before the downturn.
In good times and bad, startups should be asking themselves the same questions:
When it seems easy to extend your runway (good times), companies operate with shorter runways, they run experiments that are less likely to work, that have higher value outcomes when they do work, and they run them longer:
Let’s chase market share until we have 3 months of cash left so we can raise money at a high valuation and let’s hope capital will be available then.
When it seems hard to extend your runway (bad times), companies operate with longer runways, they run experiments that are more likely to work, that have lower value outcomes when they do work, and they run them for shorter periods of time:
Let’s raise money right now even though our valuation won’t be optimal, and if that doesn’t close in 2 months, let’s cut our burn and chase customers.
Here’s a table that summarizes the difference between good times and bad times:
|Good Times||Bad Times|
|Seems easy to extend runway||Seems hard to extend runway|
|Short runways||Long runways|
|Long experiments||Short experiments|
|Low-probability experiments||High-probability experiments|
|High-value experiments||Low-value experiments|
For some, Sequoia’s advice is good advice anytime. These people like to run their business as if it’s always hard to extend their runway.
Others (contrarians) will ignore Sequoia’s advice. They will take big risks and run their business as if it’s easy to extend their runway.
There’s nothing inherently right or wrong with either approach. Choosing a runway strategy is part of the CEO’s job description.
But our observations match Sequoia’s advice: startups that survived the last downturn ended up doing OK. They didn’t take life-threatening risks with their runway—survival mattered more than market domination.