Novice investors issue warnings as boom times unambiguously end
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Slow down hiring! Cut back on marketing! Extend your runway!
Venture capital letters are back, and they’re hot.
With tech stocks reeling through the first five months of 2022, and the Nasdaq on course for its second worst quarter since the 2008 financial crisis, novice investors are telling their portfolio companies they won’t be safe from the fallout, and those conditions could worsen.
Sequoia Capital, the legendary venture firm known for its early bets on Google, Apple and WhatsApp, wrote in a 52-page presentation titled “Adapting to Endure,” a copy of which was obtained by CNBC.
Y Combinator, the startup incubator that helped produce Airbnb, Dropbox and Stripe, told the founders at E-mail Last week, they needed to “understand that tech companies’ poor overall market performance is significantly impacting venture capital investment.”
It’s a stark contrast to 2021, when investors were rushing into pre-IPO companies with sky-high valuations, deal-making was happening at a frantic pace and bustling software startups were making multiples of 100 times revenue. That era reflected an expanding bull market in technology, with the Nasdaq Composite Index posting gains in 11 of the past 13 years, and project funding in the United States reaching $332.8 billion last year, a sevenfold increase from the previous decade. According to the National Venture Capital Association.
The sudden change in sentiment is reminiscent of 2008, when the collapse in the subprime mortgage market afflicted the entire American banking system and dragged the country into recession. At the time, Sequoia published the infamous “RIP Good Times” memo, announcing to startups that “cuts are a must” along with “the need for cash flow to become positive.”
Sequoia Capital Global Managing Partner Doug Lyon speaks on stage during day two of TechCrunch Disrupt SF 2018 at the Moscone Center on September 6, 2018 in San Francisco, California.
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However, Sequoia has not always timed its warnings. In March 2020, the company called the Covid-19 pandemic “the black swan of 2020” and implored founders to step back from marketing, prepare for customers to cut spending and assess whether “you can do more with less.”
As it turns out, the demand for technology only increased and the Nasdaq had its best year since 2009, driven by lower interest rates and increased spending on products for remote work.
This time around, Sequoia’s words sound more like conventional wisdom emerging in Silicon Valley. The market began to shift in November, as public companies paused to start 2022. The cross-currency funds that fueled much of the private market boom have plummeted as it battles historical losses in its public portfolios, said Dina Shaker. , a partner in Lux Capital, which has offices in New York City and Silicon Valley.
ready for winter
“Companies that have recently compiled at very high prices at the height of valuation inflation may face high burn rates and increasing near-term challenges in those valuations,” Shakir told CNBC in an email. “Others who were more sensitive to easing and opted to raise lower amounts may now need to consider ways to extend the runway that would have seemed unpalatable to them only months ago.”
In its first-quarter letter to Partners Limited, Lux reminded investors that it had been anticipating such problems for months. The company cited its fourth-quarter letter, which called on companies to maintain cash and avoid putting money behind unprofitable growth.
“Our companies have heeded this advice and most companies are now ready for winter,” Lux wrote.
Continuing increases in fuel and food prices, the ongoing pandemic and raging geopolitical conflicts have clashed in such a way that investors now fear out of control inflation, high interest rates and recession all at once.
What’s different this time, according to Sequoia’s presentation, is that there is no “quick fix policy solution.” What the company said it missed in early 2020 was the government’s aggressive response, which was to pump money into the economy and keep borrowing rates artificially low by Buying bonds.
“This time, many of these tools are exhausted,” Sequoia wrote. “We don’t think this will be another sharp correction followed by a rapid V-shaped recovery as we saw at the start of the pandemic.”
Sequoia has asked its companies to consider projects, research and development, marketing and other venues for cost-cutting opportunities. The company added that companies do not have to pull the trigger immediately, but should be prepared to do so in the next 30 days if necessary.
Job cuts and hiring freezes have already become a big story within the big public tech companies. Snap, Facebook, Uber and Lyft all said they would slow hiring in the coming months, while Robinhood and Peloton announced job cuts.
Among the companies that remain private, Klarna and Cameo are being cut back, while Instacart is said to be slowing hiring ahead of an expected initial public offering. Cloud software vendor Lacework announced a staff cut Friday, six months after the company was valued at $8.3 billion by venture investors.
“We have adjusted our plan to increase our liquidity path to profitability and significantly strengthened our balance sheet so that we can be more opportunistic regarding investment opportunities and weather uncertainty in the macro environment,” Lackquirk said in a blog post.
Thomas Tongoz, managing director at Redpoint Ventures, told CNBC that many novice investors are advising their companies to keep enough cash on hand for at least two years of potential pain. This is a new conversation and it goes along with the tough discussions about ratings and burn rates.
Shakir agreed with this assessment. “Like many, we at Lux are advising our companies to think long-term, extend the runway to more than two years if possible, take a very hard look at reducing burnout and improving gross margins, and start making projections about near-term future funding,” she wrote. It looks what they expected six or 12 months ago.”
In a May 16 post, “The Upside of the Recession,” Lightspeed Venture Partners began by saying, “The boom times of the past decade have unmistakably ended.” Among the sub-headings, one reads, “Cut non-essential activities”.
“Many CEOs will make painful decisions in order to keep their companies afloat in choppy waters,” Lightspeed wrote. “Some will face trade-offs that would have seemed strange or unnecessary just a few months ago.”
Lux highlighted one of the painful decisions she’d expect to see. For many businesses, the company said, “the sacrifice of people will come before the sacrifice of valuation.”
But enterprising companies are keen to remind founders that great companies are coming out of the darkest of times. Those who demonstrate their ability to survive and even thrive when capital is scarce, some believe, are in a position to thrive when the economy bounces back.
For companies that can add talent today, there is more available due to a hiring freeze at some of the largest companies, Sequoia said. And Lightspeed notes that the technology will continue to advance no matter what happens in the market.
“Despite all the talk of gloom, we remain optimistic about opportunities to build and invest in generational technology companies,” Shakir said. “We are encouraged to see our CEOs exchange notes and advice with each other, while being energetic and humble due to these changing circumstances.”
Correction: This story has been updated to reflect this cloud software vendor Lacework has raised $1.3 billion in growth funding at a valuation of $8.3 billion.
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