“Every incremental day that goes past I have this feeling a little bit more. I think that Silicon Valley as a whole or that the venture-capital community or startup community is taking on an excessive amount of risk right now. Unprecedented since ’99. In some ways less silly than ’99 and in other ways more silly than ’99.”
– Bill Gurley to the Wall Street Journal, September 15, 2014
I may be in the minority but I remember 1999. In 1999, I was part of a bubble that made the dot-com bubble look small. Sure, those were the days of Pets.com imploding and Amazon’s stock going from $107 to $7 per share.
But I was a part of the telecom bubble, borne out of excessive spending by telcos on spectrum, fiber optic cable in the ground spanning the world, and a massive data center build out. About $2 trillion was lost in telecom market capitalization by 2001, by both well-established companies (MCI, AT&T) and startups (Exodus, Level3, Global Crossing). It was a period when companies were valued as a “multiple of gross PP&E” – or basically, the more money you spend on assets in the ground – the higher your valuation. At least with eyeballs you are dealing with customer acquisition, with PP&E, you’re talking about outdated optical equipment. During that time, I helped start FirstMark Communications – a startup for which we raised $1 billion, including $600 million from private equity firms (KKR, Goldman, Morgan Stanley and Welsh Carson) and $400 million of debt. The story did not end well.
Which brings me to 2014, and the recent spate of articles cautioning startups that the current tech valuation levels might not last and warning startup founders to be careful about raising hundreds of millions of dollars on companies with extraordinarily high burn rates. That is good advice, but hard to accept for entrepreneurs who have never really operated in the dark days; and much easier said by investors than done by entrepreneurs when every force around them pulls in the opposite direction.
Let’s put aside the question of whether or not there is a tech bubble and ask the question – how should a CEO or founder operate in the midst of one?
Gurley says the answer is being “pragmatically aggressive.” I think the real answer is that there should be very little difference in how you operate your business in a bubble world or a non-bubble world. Sure, the cost of or access to capital might be different in the two scenarios but the truth is that for most software, Internet or other low-capital-asset businesses, the cost of capital is far less correlated to success than the use of that capital. Let’s take two cases: You are operating in “normal times” and you need to spend $100 to acquire a customer, versus you are operating in “bubble times” and it costs $200 to acquire a customer. Given that most business cycles, up or down, last three to five years and the lifetime value of your customers likely does not change in the two cases, you should be willing to spend roughly the same amount in both cases. The fact that you can raise $50 million at a $500 million valuation versus raising $50 million at a $250 million valuation should not impact your fundamental decision-making. If the “normal” case only allows you to raise $25M, then you really have to ask yourself whether the incremental $25 million really changes your calculation. In a world of natural capital abundance for good businesses, I would argue it mostly should not (i.e. if you can only raise half the money today, but if you deploy it to good use, more capital will likely be available downstream for you anyway). There may be a difference in ultimate founder / early investor ownership but not likely in ultimate outcomes.
The playbook for operating in a tech-bubble involves mostly blocking the noise out:
- Stop worrying about how high Uber’s valuation is: First of all, their valuation does not impact your valuation. The only thing worse than spending large amounts of money unnecessarily or raising money at outrageous valuations that you don’t deserve is doing so because someone else did. I get the competitive fire that most founders/ceo’s have about being best-in-class but worry about the hand you’re dealt, not the one you wish you’d been dealt.
- Play for long term: Remember, you are playing for your product vision and potentially towards an exit that takes several years. Responding to current market forces in ways that diminish the value of the long-term to get a short-term pop almost never works.
- Over-communicate to your team: Everyone reads TechCrunch. I had one engineer ask me at what price I would be a “buyer and/or seller” of BloomReach stock. Others will be influenced by the events around them and it is important that you continue to explain to your team the various forces that ultimately impact your value and their equity value.
- Resist the temptation to massively over-pay or over-hire: The natural conclusion of any self-respecting entrepreneur in a capital-abundant environment is to raise too much capital and then over-pay or over-hire in a super-competitive job market. Don’t do it. It will create fairness issues with your team downstream; and if you over-hire when the risk profile of your company doesn’t permit it, you will ultimately be faced with painful layoffs. Explaining the cuts to your team will damage morale much more than the gains incurred by over-hiring or over-paying.
- Only raise money at a price that you have a line of sight towards being priced at in “normal” markets: Just because investors are prepared to value your company at billions of dollars doesn’t mean you take their money at those prices. At some point those investors will want a return; and just the psychological burden of knowing that you need to actually earn out an unattainable price can destroy a founder or a CEO. If you at some point need to do a down round, the financial and cultural costs are massive. Mitigate that risk.
- Burn as much money as you would in “normal” environments: Remember the good days will end and you will ultimately be held accountable for what you did with your capital. Usually, in any high-growth environment, there are only so many things you can execute on in parallel and generate a good return. Stick to those.
I’m not suggesting that you should not be opportunistic in good times. Certainly plan your fund-raise to take advantage of the opportunity, negotiate the best possible deals with investors, consider exiting, and (at the margin), be slightly more aggressive.
But mostly, as you are faced with the innumerable pressures to take advantage of the tech bubble, step back and take a walk around your (overpriced) office space. Then come back to your desk and make the unnatural move:
Don’t change anything.