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Amid plummeting stocks and political uncertainty, VCs urge their portfolios to prepare for winter

The warning signs are flashing faster and more furiously now and investors are increasingly urging their startups to take notice.

With the Dow Jones Industrial Average enduring a Christmas Eve rout of historic proportions and other indices entering bear market territory, the long-predicted end of the latest bull market is upon the technology industry.

While tech companies managed to escape the worst parts of the great recession in 2008, increasing regulatory scrutiny coupled with a broader set of economic risk factors (including a trade war with China, flagging domestic industrial spending, and — perhaps most worrying — the $9 trillion in debt sitting on corporate balance sheets) may offset projected growth in information technology outlays from companies to create a scenario where the roaring teens of the tech industry’s millennial years head into the terrible twenties of the new century.

That means venture capital investors are once again breaking out the RIP Good Times slide deck from Sequoia Capital and cautioning their portfolio companies about what comes next.

“In the course of preparing plans for 2019, most of our mature companies have internalized the risk for a downturn, but I think it’s hard to really model what the impact will be,” wrote Founder Collective managing partner David Frankel in an email. “You could imagine a slowdown in capital markets due to a rise in interest rates, that might hurt some companies that are overly dependent on VC, but leave the strong companies largely unscathed. It’s also easy to imagine a more systemic correction that decimates the verticals that were (& this will be easy with hindsight of course) ‘vitamins’ not painkillers.”

For some startups that means making hay while the sun shines and raising more capital now. As Joshua Hoffman, the chief executive of synthetic biology startup Zymergen, explained to Bloomberg when discussing his recent $400 million round led by SoftBank Vision Fund, “We wanted to have some fat on our bones for sure… The time to raise money is when people are giving it to you.” (Even if that money is tied to the dismemberment-and-beheading-happy Saudi Arabian government.)

For some, the times look very similar to the early 2000s when the dot-com bubble burst. In 2000, venture investors put around $99 billion into venture backed startups. Eighteen years later that number is roughly $96 billion.

In the first year of the new millennium a Japanese firm called SoftBank had established a worldwide network of funds to invest hundreds of millions of dollars into startup companies that were going to revolutionize the technology industry. Now, SoftBank is once again the firm throwing millions (hundreds of millions) against the proverbial wall in hopes that billions will come bouncing back.

Venture firms are expected to raise around $45 billion this year, while back in 2000 funds were sitting on about $80 billion in capital, according to a 2005 study from University of Western Ontario professor Milford Green.

There are important differences between the early part of the millennium and today’s technology and venture capital markets. Business models for technology companies are far more mature (Apple, Amazon, Alphabet, Facebook, and Microsoft are among the world’s most valuable companies) and the replacement of “eyeballs” with ad dollars can’t be overstated as an engine for economic growth and value.

At the same time, the fact that an entire generation of entrepreneurs have not experienced an economic down cycle is a sign of concern for some investors.

“There’s a large cohort of founders who haven’t seen a down economy and that’s a risk to the ecosystem,” Frankel writes. “Many founders believe that in a weak economy, that they might have to accept a down round, but few have grappled with the reality that capital markets don’t soften, they seize and capital just can’t be had, at almost any price, for months or more.”

So investors like Lux Capital’s Bilal Zuberi has begun advising portfolio companies to start preparing for times they’ve never seen. Winter… is indeed coming.

In a direct message Zuberi wrote:

“Yes, for all obvious reasons we do believe startups should be thinking hard about their capital needs going into 2019 and beyond, and how to not get caught in a firestorm. (a) the amount of money flowing in SV startups has meant startup teams and investors are not used to being frugal. Consider this, many junior partners at VC firms have never seen an economic downturn — and they are sitting on Boards of startups spending tons of money, (b) raising money sooner than later, but not increasing burn is a prudent thing to do for companies that have access to more capital, (c) when downturn hits there will be special situations opportunities to invest in good companies but at lower valuations. All VC firms know…But I wouldn’t want any of my companies to become a ‘special situation’. So fighting hard now to reach escape velocity is also prudent. And (d) you are seeing VC firms bulk up their own funds, raise debt funds, and so on…this should be a signal to startups that where capital flows from upstream is starting to worry. Smart founders should take that as a signal, and prepare accordingly.”

For Zuberi, preparation means a few things. Founders need to think about their financing plans beyond the next 12 to 18 months, and raise capital only if that cost of capital is low. Preparation also means keeping tabs on burn rates and financials in general, and begin planning on how to move aggressively should competitors start becoming “special situations” that investors may look to offload.

Of course, there’s still the possibility that all of this worrying will be for nothing. Bill Gurley warned about a culling of the unicorn herd in 2015, and there have been rumblings about a startup crash since the Brexit vote went through.

At this point though, the parallels are beginning to look more than eerie and it may behoove founders to take the warnings as more than just another instance of investors crying wolf — if only because it seems that the wolf is indeed at the door.

source: TechCrunch