Why the startup funding bust will be a beautiful thing...

Map of the South Sea Bubble c1720

One thing is certain

This week has seen a several interesting posts about money. Authors highlight the unusual funding structure of the current startup boom. The basic point is that most of the money invested is private. Many entrepreneurs and early investors prefer to avoid the public capital markets altogether. This Quora answer from Keith Rabois explains why the IPO is out of fashion. The result is large funding rounds for mature companies with established revenues. But the risks of this type of investment are much greater than listing on the stock exchange. Bill Gurley set this out in his article. It also means that investors money is tied up for long periods. Institutional Investor claims that VC funds now have a life expectancy of 14 years. The normal planned exit is after 10. 

Huge flows of money have resulted in fast rising valuations for start ups. There is plenty of speculation that we are seeing a repeat of the Internet 1.0 bubble. One thing is certain. There will be a correction. That is the logic of markets. Whatever the "fundamentals" prices will fall at some point. This raises two interesting questions:

1.         Who will lose out and what might be the wider economic impacts?

2.        What changes will startup entrepreneurs and teams experience?

I will try to answer the first question in a future column. This one is about question 2.

The money switch trips

The fund raising environment will change. This is pretty obvious and it will be the first thing most people notice. Meetings with investors will become rare. VCs will announce they are “changing their investment strategy.” AngelList’s homepage will display far more pitches with much less progress. Talk about lack of deal flow will stop. This switch will flick overnight. When it happens do not deceive yourself. The money will not come back for a long time. Trailing round chasing the vanishing puddle of cash will be a mug’s game.

The ecosystem evolves

Of course the startup ecosystem is not just about money. There is a lot of other support around. Incubators and accelerators, Universities, public bodies, mentors and advisors. All are investing time, expertise and sometimes a bit of cash. A downturn in valuations will show you who is making a strategic choice. And who is just jumping on the bandwagon.

Advisors will be the first to disappear. Professional services is an industry that has to chase short term cash. Not everyone will walk away but many will. Mentors will split. Those who have committed will double their efforts. Others who are just exercising their egos will stop taking calls. I just hope that Universities and public bodies will stay in the game. If Government investment is worth anything it must be for the long term.

The number of incubators and accelerators will shrink. The survivors will only focus on real business quality. Hubs  built around creating great pitches and raising funds will not make the cut.

Culture shifts

Startup culture will experience a more subtle change. Today it takes a lot of determination and resilience to be a successful entrepreneur. The challenge will multiply in a downturn. Lots of startups are nurturing. Many try to live real values and ethics. The investor spotlight will turn on the perceived costs of these attitudes. The great businesses will not be tempted to change. Strong and sustainable culture is essential to long term success. 

One big risk as the culture shifts. Diversity is already low but could be a major casualty. Women, minorities and those from less blue chip schools or family backgrounds could easily lose out. To everyone, don’t let this happen. Please.

Cash is King...

The work and social environment will change fast. You will feel it immediately and most of those feelings will be negative. But none of these changes matters that much to a startup. The big one is cash crunch. The harsh reality of commerce will reassert itself. No money, no business.

...long live the King

Reduce burn, get cash positive or die.  At the same time keep margins rising and aim for higher growth. This will be the day to day operating environment. The pressure will increase as investors feel the pain. Angels and VCs will demand cash distributions. Dividends, interest, loan repayments. Only the very strongest will survive. They will share three things:

• A clear understanding that the only metric that matters is cash flow. One day you will walk into your office and make a choice. Do you turn on the lights or not? Then you will understand this.
• An ability to make tough decisions fast. Couple this with a humane and honest way of executing.
• The courage to buck the trend. Success will still be about growth and vision. Remember buy when everyone else is selling.

And beauty came like the setting sun:

There is no way of writing this that does not sound negative and scary. There will be a lot of casualties and not all will deserve to fall by the wayside. But the outcome will be beautiful. 

When the sun rises the landscape will be clear and simple. The tech industry will have created the next generation of greats. They will not be unicorns. They will be the companies that made it into the ark. That worked as teams and maintained their values. The ones that will change the world.

How can you build a great business that will have the strength to survive? What advice would you give to an entrepreneur when the easy money dries up?