This past weekend, I sent the email below to the 250+ founders I’ve invested in. The goal of this email was to prepare my founders for what happens to startups when a market corrects and then collapses.
I’m not calling a top to the market, or a crash, but rather giving my founders a blueprint of how to survive and thrive in a down market.
I hope this is helpful to you as well. Feel free to forward it to a founder you know, as they might not be thinking about these issues.
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Launch Portfolio Founders,
We are in year 10 of the current bull market.
Chaos reigns from Washington to Moscow and all of you are all competing for attention for customers and talent with an unprecedented number of highly-skilled founders running impressive businesses.
Having seen this movie up close three times in my startup career, I wanted to take a moment to explain to you what happens to startups when markets correct — and sometimes collapse.
In short, I want to explain to you how to avoid having your startup die when the stock market crashes — just in case the market turns.
In my estimation there is a 20-30% chance we could have “an event” in the near term (the next two years), and since there is never a bad time to make long-term plans you should read this email twice, and discuss it with your senior team.
There is zero cost to taking this information dead seriously, and there is a massive downside to ignoring what follows: the “risk of ruin” (as we call it in gambling).
Paradoxically, there is a MASSIVE opportunity to build in a down market.
As I’ve told many of you over the years: “fortunes are built in the down market, and collected in the up market.”
The last couple of major “events” included the Great Recession (caused by real estate shenanigans), 9/11 (caused by terrorism) and the dot com bust (caused by irrational exuberance & financial shenanigans).
Two out of the last three were financial shenanigans, which is to be expected. Today we have cryptocurrency, monetary policy, trade policy and student debt leading the list of financial shenanigans that could cause the next correction/collapse.
In the Black Swan, non-financial event category we could list Russia, North Korea, China, Pakistan, Iran, domestic political unrest and the Mueller investigation as market busters.
These type of events can result in stock market corrections (a 20%+ retreat in prices according to most definitions).
When the stock markets corrects, most of the time it simply bounces back, but sometimes a contagion will occur and it will impact everyone from hedge funds to angels, and the venture capitalists and seed funds in between.
When things go really bad, all asset classes tend to go the same direction: down. No one is spared the pain, but the degree to which the pain is distributed can be very different (i.e. bonds, domestic stocks, international stocks and real estate).
The winners are those with massive cash positions they are willing to deploy.
Again, sometimes the correction is just that — and it has no impact on startups.
No one knows!
What we can do is look at what has happened in the past. Here is a basic rundown of what happens in the case of “an event”:
- Event occurs (Black Swan or anticipated)
- Stocks sell off, a series of head fakes occur around recovery, selling continues until a bottoming out.
- Venture Capitalists decide not to make capital calls to their Limited Partners, sometimes as a courtesy, other times the result of a directive. They know their LPs have been heavily impacted by the market collapse and don’t want to stress them more.
- Fight to qualify: Portfolio companies that are profitable have opportunity to get additional funding to deploy in the down market to capture market shares.
- Portfolio companies that are close to profitability are forced to take a haircut on financing rounds — if they can even get them (think down rounds, warrants and multiple liquidation preferences).
- Struggling portfolio companies are left to figure it out for themselves.
- Seed Rounds Plummet: New startups will get funded at half to 1/3rd the price of similar companies the year before (i.e. $2-5m compared to $4-15m today).
- Costs to acquire customers (ads), talented employees and M&A all plummet — allowing the strong and well-funded to become unstoppable (think Netflix, Google, Facebook and Amazon).
After a crash, the stock market tends to recover in a couple of quarters (think three to six).
The startup market, however, lags two or three years behind the public market recovery because angels and LPs who lost all their money will swing from being greedy to fearful.
Right now we are at Peak Greed, with investors in unicorns, real estate and public markets all excited to deploy capital.
After the Great Recession, these same high net worth decision makers were figuring out how to rent or sell their second homes, deal with having to fly commercial again and downsize their domestic staffs.
It takes years for these high net-worth decision makers and stewards of capital to regain their confidence — years that 80% of startups don’t have.
When high net-worth investors (HNIs) clean up their personal balance sheets and deal with the horror of losing half their chip stack, they will invest in your crazy vision again — but most founders will be out of business by that time.
The Startup Preppers Disaster Planning Guide
If you take the advice outlined below, you will be able not only to survive a crash, but even to take market share through it.
Step One: Imagine that ‘the event” occurred today; ask yourself the following questions:
- Am I at, or can I get to, profitability on the money I have?
- Am I in the top 1/3rd of my investors’ portfolio?
- Are my customers loyal enough to keep consuming my product in a down market?
If you answered yes to all three questions above, congratulations you’re crushing it!
Go raise “opportunistic money” from your existing investors at a good or great price — they will be happy to own more of your company and help you cement your win.
If you answered yes to one or two of these questions, congratulations, you’re doing good work!
Go raise money from your existing or other investors at an OK or good price — they will be happy to own more of your company and see you get to the point of answering “yes” to all three questions.
If you didn’t answer yes to any of these questions, you’re either very early (reasonable), haven’t found true product-market fit yet (reasonable) or you’re not a good founder (why are you doing this instead of working for someone else?).
If the reason you didn’t answer yes to any of the questions is you’re early and trying to find product-market fit, go raise enough money from almost anyone (no judgments), so you have 18 months of runway and you can figure it out.
If you’re reading this and have the feeling that you’re not cut out to be a founder, now is a fine time to merge your company with another founder and startup you highly respect and go kick-ass on someone else’s management team. (Of course, most folks are not self-aware to understand this.)
Bottom line: In almost all of the cases above, my advice is to build a war chest of capital so that you can deploy it in the down market.
In all of these cases, you want to raise from the best investors you can at the best price you can, but what you should not do is risk having less than 18+ months of runway in your bank account.
How to Win the Down Market
If we do enter a down market, and you have 18-36 months of capital in the bank, you will be able to capitalize on the following:
- Attention: Consumers and businesses will have fewer people asking them to try their products. This means it will be easier to get sales meetings and consumer trials.
- Lower Costs: You can literally go to all your vendors and ask them to give you a 50% discount and watch most of them offer to keep you as a customer at a lower price!
- More Talent: As startups shutter and big companies do rounds of layoffs, you’ll be able to find talented people at reasonable prices — go get ‘em!
- Marketing: The cost of marketing will plummet as demand dries up. Think about, if you’re a CEO and the market crashes, do you want to spend $30,000 a month for a billboard on the 101 freeway? No, you want to put that money toward customer acquisition. But what if you could get five billboards for $30,000 and that resulted in a great ROI? Well, then that’s what you’d do!
Down markets are wonderfully quiet and efficient times for well funded startups.
If you’ve gotten this far, what I am imploring you to do is “top off” your funding. There is little downside to topping off, and there is a significant (perhaps 10-30% chance) risk of ruin if you don’t.
There is, of course, the possibility that we will have the longest bull market in history, with another decade of “up and to the right” in all markets!
In that case, well, we will all be fabulously wealthy and we can all consider this a monotonous, while virtuous, fire drill.
And, in that case, you will still be glad you built your company on the premise that not a single dollar of future capital is a sure thing.
PS – Back in the day, Sequoia Capital sent me a similar warning. It was amazing advice for startups in their community, which became relentlessly focused on delighting customers and finding repeatable, high-margin, business models.