On Friday it seemed like everyone in the venture capital industry was again reading about market turmoil, this time the news is that angel investors are pulling back and valuations taking a hit. I read it too, because it’s a big deal. Startups everywhere will need to adjust their fundraising strategies and good investors will be helping them to adjust quickly – it’s much less painful that way.
However severe our current situation is, I’m sure there will be plenty of short term negatives, including more job losses, company failures and down rounds. However, every cloud has a silver lining and this time I hope it’s that out of the current correction/crash (wherever we end up) comes a more sustainable model for startup growth.
In his post The end of the big venture formula Danny Crichton put it like this:
What’s needed is a sustainable approach to startup growth and venture capital. That means much less blitzscaling (whatever the heck that ever was), and lots more heads-down quality thinking to build products that customers actually want and will eventually pay for. We need a new disruptive capitalism that is designed for a much more mature internet market, one that can bring founders, investors, and employees together.
I would summarise that as getting the fundamentals right – from great product, through unit economics to stakeholder alignment.
Crichton went on to highlight three myths that are preventing founders and investors from focusing on fundamentals:
- Growth is limitless in a world where 3bn people are connected to the internet and the other 4bn will be online soon
- The best startups capture all the returns so focusing too much on entry valuation is a mistake
- Scale is everything, and all else should be sacrificed for it
I would say there is some truth in all three myths but not enough to make them useful rules of thumb. In the ecommerce and marketplace markets Forward Partners operates in growth is limited because business has to scale country by country. It’s easier than ever before to do that (we have a 4 month old ecommerce company experimenting with US expansion) but still hard work. Secondly, there is definitely a power law in venture returns, but in the now huge global markets the winner takes all dynamic is weakening, and only chasing unicorns misses the huge opportunity in companies with $100-1bn exit potential. Thirdly, in early stage startups, scale, or more precisely growth/momentum, is hugely important but if the unit economics are never going to add up then you don’t have a business.
It’s worth remembering that there’s some game theory at work here. If the markets are only focused on scale then focusing on fundamentals risks seeing a competitor raise more than you, grow faster, and make it much tougher for you to raise more money and grow customers yourself. And so long as there’s a bigger fool out there focusing exclusively on scale often works out just fine.
Most long term venture industry insiders prefer operating in a steady climate where companies don’t have to follow highly risky strategies just to stay competitive. I think that’s why you see people like Bill Gurley, Fred Wilson and Mark Suster publicly talking markets down. They are hoping the ‘bigger fools’ will step out and we can all get back to focusing on fundamentals.
I’ve written a lot on this blog about two aspects of fundamentals – great product and strong unit economics – but less about stakeholder alignment. I will look into redressing that balance, but my first thought is that because of current practices/trends towards non-participating preference shares and early founder/employee/angel investor liquidity this is the one front on which we’re not doing too badly.