More on the lean times / VC / startup front

In three accounts over the last week and a half (here, here, and here), I've mentioned how the chaos of financial markets is spreading to the tech sector, and what that might mean for the timing, scale, and duration of damage to the "real" economy in which companies make products and create jobs. 

Central to this discussion has been a grim report from Sequoia Capital, in California, arguing that startup companies had to strip themselves to bare bones if they hoped to survive they next few years. Of course the process of stripping, which involves laying off employees and cutting all costs, perfectly illustrates how economic damage cascades

Some people have written back to say that the report was prescient; others, that it was part of a perhaps too-alarmist swing by the VC community that, whether or not this was its intention, had the effect of terrifying startup companies into accepting much tougher terms from funders.

After the jump, a contrarian view from Alan Patricof, the managing director of the New York VC firm Greycroft Partners, taken from a message to associates this month. Eg, "This is not a time to panic, cut off all investment in the future, and burrow into a dark hole. Take a page from the packaged goods industry that the time to gain market share is during tough times when your competitors are weaker in responding." Because Patricof makes some political comments, it's relevant to note that he has been a leading backer of Hillary Clinton's senatorial and presidential campaigns.

I realize this is not a black/white, all-or-nothing question -- Sequoia was recommending very selective investment too. And I don't intend to run endless back-and-forths. Still, I thought this was a worthy equal-time complement to the preceding argument. And, as my friend Ted Schell of New York, a former associate of Patricof's, has noted, it may illustrate an East Coast / West Coast difference in outlook, with the Easterners atypically more optimistic: "Frankly I think the west coast VC community [including Sequoia] is much more inclined to excesses than the east coast - excesses in valuations, amounts invested, return expectations and reactions to floundering or under performing companies." More below.

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From an email to associates from Alan Patricof, managing director of Greycroft Partners, earlier this month:

The comments made by the partners of Sequoia Capital at their recently held "CEO Summit" have been widely covered by leaks to numerous bloggers.  These bloggers have disseminated the details and spread the contagion of the sentiments to the public at large, unfortunately running the risk that the words become a self-fulfilling prophesy.... 

Certainly, we are going through a period of enormous economic and political uncertainty.  The loss of confidence, primarily in our financial system, as a result of the excess of the past five to ten years (if not longer - we may never know how long some of the flawed practices have been going on) is one of the leading contributors.  We are also at the moment looking for leadership on the political front and both because of very low public support for the President and because we are in the midst of a heated election for his successor, we have no real voice of authority to provide some guidance, reassurance, and inspirational confidence that the bus has a driver who knows where he is going. 

 
Nevertheless, aside from an over inflated housing boom that had to collapse sooner or later and a complicated financial system that arose in part to fuel this engine, the basic economy was in reasonable shape with GNP growth and productivity gains supporting a solid, if not vibrant outlook.  (I know the automotive industry is also going through bad times but it no longer pervades the economy as once conveyed in the expression "As GM goes, so goes the nation.")
 
Advances in technology are allowing companies to make goods and provide services faster and cheaper.  The wireless revolution and the Internet have made the dissemination of information easier and more pervasive for the entire world and brought significant benefits to every phase of our economy.

That is not going to stop although it may temporarily slow down.  In these difficult times, there will be winners as well as losers (and the former may be fewer in number for a while).
 
The point is, the financial problems are being addressed, if not a bit belatedly, and some international mechanism will be found in short order for some coordinated policy that will restore order and confidence to the system.
 
Most young companies, with which we are specifically concerned, are financed with equity capital.  That has its positives and negatives; on the one hand, debt is a very small factor in the capital structure of most small companies so loan foreclosures and the interest rate burden are not of prime concern.

On the other hand, equity capital, which is provided by private investors, requires confidence in future prospects for reaching profitability and creating a strong market value.  Certainly under current conditions it is hard to engender such confidence although history has demonstrated that it is in times like these that great opportunities are created.  I have always said, "The best time to invest is when the drums are beating, not when the trumpets are blaring!"
 
This is surely a time for companies to pay meticulous attention to detail, particularly their cost structure. It is a time to be realistic in their near term assumptions for revenue growth and take nothing for granted.

Raising additional capital to support operations is of course critical, as it is at any time, but this is particularly a time for young companies to be extra cautious in developing pragmatic assumptions of their needs and in focusing on the amount and not necessarily the cost of that capital.
 
This is not a time to panic, cut off all investment in the future, and burrow into a dark hole.  Take a page from the packaged goods industry that the time to gain market share is during tough times when your competitors are weaker in responding.  And while this may feel more directly related to portfolio companies, we as a venture industry should not retreat either.  It is our strong belief that we can and will continue to make sound investments in excellent opportunities.  It is as good a time as ever to start a company with sound fundamentals.

 
So my point is to heed the caution of the Sequoia comments but to use them only as a strong message to reexamine all cost elements and growth plans and use this opportunity to assure that you are a survivor.  Find a way to use this moment to gain your greater share of the market by providing a solution that is needed by others to improve their prospects in the difficult environment ahead.  Tighten your belt and live within your means.  Although the timing makes this message seem more prescient, it is a philosophy that works for successful companies at all times and at all stages; it is simply put, good business.  This is not a time for heroes!