Brace for Impact

Those of us who have been in Silicon Valley for few years now have been through bombastic highs and lows which seem, frankly, far from the lows of this blogger’s humble beginnings. Yet despite our roots in paranoia there’s been a certain feeling of invincibility in the face of difficult odds which typifies the Silicon Valley entrepreneur. That’s worth remembering as business cycle gravity takes hold and we head into an era of far slower growth and possibly contraction. It’s also worth looking a hard look at the tactics which will increase survivability in tough times, even as the balance of power has tipped heavily from entrepreneur to investor in the span of two weeks.

The Only Thing We Have to Fear is Fear Itself

Sensibly, some investors have been quietly coaching their investees on strategies to come out of the economic black hole. It;s understandable, as this downturn is different than most since mortgage equity withdrawal is no longer fueling domestic consumption. Sequoia Capital’s downturn strategy presentation to its funded entrepreneurs has leaked out and added to dread. Oh and the first slide doesn’t help:

Startup angel investor/advisor Dave McClure “smacked-down” doomsayers, calling on them to persevere like the fictional desert-dweller Muad’dib. In Dave’s words:

the companies and people i bet on HAVE to be both optimistic & opportunistic, if only because THE ODDS AGAINST STARTUPS SUCK ***ALL*** THE TIME, not just in downturns.  you damn well *better* have a positive attitude, or you’re just never going to get out of bed in the morning.

The messenger is overpowering the message a bit here, but he’s essentially correct. Ramen-profitable businesses are best poised for long term success and high cash-burn businesses aren’t, irrespective of the general economic climate. Besides, a number of macroeconomic factors are in our favor here. To see why, let’s take a stroll down ancient history. The last time panic set in here was in in 2000-2003, where highly leveraged debt crushed a number of startups who tanked when the interest payments began to far outpace revenues. We’re talking 9:1 debt/equity ratios here in some cases – not pretty.

The Force is With You, Young Jedi

Nothing like this exists in the post-Web 1.0 world, where capital requirements for startups are a fraction of the massive costs incurred laying down fiber optic cable to found the original web. How many Web 2.0 startups burn through 300 million in a few months? None, and that’s the point. Web 2.0 startups have a far quicker time to utility and require far less capital and hence are imbued with a lower burn rate right out of the gate because of lower financing costs. The best visual I’ve seen of the differences between Web 1.0 and 2.0 startups was in Amy Shuen’s book, which I’ve semi-plagiarized below..

Visual Representation of Web 1.0 v Web 2.0 Profitability Over Time (x axis)

The most successful founders I’ve met are far more MacGwyver or Luke Skywalker than Jack Welch, and the evaporating time to revenue driving Web 2.0 startups make it easier than ever to be a entrepreneurial Jedi. It’s never been easy, but has never been easier than now.

Tactical Maneuvers

This blog tends to focus on ideas and possibilities, mostly because that’s what I enjoy reading and speaking about. However, bracing for a slowdown tends to make such talk seem a bit trite. So while others have made lists of things you can do right now to depression-proof your startup, it might be worth adding a brief list of things I’m observing from the fault lines. Here’s what entrepreneurs I know personally are doing now to weather the economic storm:

1. They’re Communicating. Our CEO assembled the team to address the economic crisis as the full brunt of reality hit Wall Street. The message? We’re a software as a service company, and positioned for success when potential clients are looking to outsource to lower burn rate. He asked us to filter out the noise and focus on executing. Have you done the same? If you haven’t, let me assure you your team isn’t focused on executing right now – they’re focused on what they will do if they lose their jobs. Speaking of which..

2. They’re Dumping Mr. Milquetoast. This one is uncomfortable to speak about, and I’m not suggesting that layoffs is to be taken lightly. Having said that, a highly motivated, smart teammate is worth many average ones. We’re likely to see a few more announcements like the one made by Loic LeMeur in the new few weeks. Which leads me to the next point..

3. They’re Investing in the Core Team. This is always a good thing to do, regardless of the macroeconomic circumstances. Calancais dropped this nugget of common sense in his post:  “Invest in training and education of your top people, because they are the ones who will lead your company through this mess.” Besides, there’s inherent risk mitigation in a slowdown anyway – the top people you train are less likely in a recession or depression to jump ship, giving you a longer investment horizon.

3. They’re Finding a Revenue Stream and Hanging on For Dear Life. The expression “cash is king” is truer now than ever. A few startups I’m familiar with have changed strategic direction in a matter of a day or two to  generate cash flows. No joke. Every startup I’m familiar with is also making a list of their top 10 customers (by cash flow of course), and is calling on them all the time to make sure they won’t leave. Bonus points for developing new revenue streams from clients who are already reliable about paying you.

4. They’re Forgetting Seed Capital. Seed and early stage capital are the first to dry up going into a down cycle. Every time. There are two reasons why. The first is that investors who are currently long on a few startups are going to try to nurse those startups that much more to mitigate their risk. That is, they’ll spend a whole lot more time with their current portfolio and forget acquiring new startups. The sceond reason has to do with business cycles and value investing. Simply put, if you think spending will rise in the macro economy, it makes sense to invest early in promising startups to get in on the growth for a bargain price. That dynamic works in reverse going into a downturn. For more reading, hit up Fred Wilson’s “Startup Depression” post. In short, bootstrap if you can, or fund your new venture out of current services you’re providing. Now would be a great time to turn your consulting project into a product.

5. They’re Taking Root. It might be tempting to pull out of the domestic market and try to jump into China, but hold on before you do. The Chinese haven’t focused on building up domestic consumer markets fast enough to head off the U.S. slowdown – which they should have seen coming when American consumers began cannibalizing home equity to support unsustainable consumption. Driving growth through an addiction to US Dollars will now start to stress newly minted graduates who will have a tougher time finding work when the Dollars stop flowing (it was already tough for many of them, by the way). Paul Denlinger has more analysis here. For good measure, I’ll mention the Euro region isn’t going to fare much better.

6. They’re Renegotiating Everything. Try to negotiate with your credit line suppliers to give yourself some extra breathing room (it’s unlikely, but worth trying). Renegotiate with your every supplier provider and insist they reduce prices or you’ll leave them. More often than not, it will work – remember #3 on this list?

7. They’re Preparing to Feed off the Dying. An item that caught my eye from Jason’s “10 Things to Do Right Now” is this little quip:

Make a list of every Web 2.0 startup to raise an A or B round and cross 80% of them off the list, because they will not make it to their next round of funding or profitability.

Every single startup CEO or GM I’ve spoken with has told me he or she is targeting the “walking dead” amongst their competitors and are preparing to strike at their customer list.

8. They’re Connecting with Others. Here’s some additional reading material to get your business geared up for the coming downturn. If you can contribute, get involved in the discussion!

The Startup Depression

VC Fred Wilson’s Thoughts

What Startups Can Learn from Sequoia

15 Ways to Cut Your Home Budget by Mukund

The Economist Magazine’s background on the downturn

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This entry was published on October 13, 2008 at 12:25 AM. It’s filed under Uncategorized and tagged , . Bookmark the permalink. Follow any comments here with the RSS feed for this post.

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