A lot of criticism has been aimed at venture capitalists the last few days. The VCs are telling their portfolio companies to get ahead of the curve and conserve cash right now, and companies are starting to take their advice.
The criticism is coming from people who don’t understand that the world has changed in the last week and that companies need to change with it. And so they’re asking why VCs waited until now to tell everyone to conserve cash. Others are saying the boom is the VCs fault, and for them to lecture companies on conserving cash is ironic.
Fred Wilson wrote about this issue today and says VCs have a responsibility to give their best advice to their portfolio companies: “It’s all about acting responsibly and making sure we all survive to fight another day.”
But he doesn’t address the issue head on. I will. What we’re talking about is the goal of profit maximization, which is what every for profit business needs to aim for or go out of business. In the good times, that means growing intelligently. In the bad, it means maximizing your chances of survival.
Irrational Argument No. 1: The VCs Made This Happen
First, the downturn has nothing to do with the venture capitalists (in fact, it has nothing to do with Silicon Valley, this time). They have one job: generate the best return they legally can from their investors’ money. In boom times deals get competitive and VCs make independent decisions on what deals to bid for. Companies also have to pay more for people, resources, office space and advertising in boom times, which means they spend more money and have to raise more money. If you think venture capitalists are being irresponsible (or worse, evil) by investing money in those companies that they think are good bets, you’re just not getting how the whole system works.
Let me put it this way - if VCs ignored the economy and always invested super conservatively so that no one could accuse them of being irresponsible, they’d go out of business after their first fund failed to return capital to investors.
Irrational Argument No. 2: VCs Should Have Told Companies To Conserve Cash All Along
This is another argument that ignores the fact that people try to adapt to a changing world. At all times companies need to profit maximize. That means maximizing revenue and minimizing costs. Those goals are not aligned, however. Sometimes a company spends money on research and development to create future revenue streams. How much they spend is based on their own rational decisions on their financial health, the state of the economy, and their projections for the demand of a new product.
In good times, when core businesses are relatively safe, it makes sense to expand by hiring new people and developing new products. Or spending money on advertising and PR.
When times are tough, companies have to change strategies. They’re still maximizing profits, but they need to plan for tighter capital markets (really important to unprofitable startups) and harder revenue as advertising and other spending decreases.
Just like a bear in the woods (I imagine) has to slow its activity in the Winter as food supplies dwindle, startups need to go into cash conservation mode to increase their chances of survival when the market slows. They need to be prepared for a hit in revenue, and they know they can’t necessarily go to the capital markets to get money to stay in business.
But to argue that a company should always cut costs to the bare minimum is the same thing as asking that bear to act like it’s Winter in the Spring, just because someday Winter is definitely going to happen. All you end up with is a dead bear.
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“Venture Vultures” hoovering over the compaines they once idolized and praised.
what are u talking about now? jeez, this guy never stops the kak dribbling from his mouth
pleasestoplocator.com
Seriously you are one of the dumbest people I’ve ever encountered online and that’s saying something.
everthing here makes so much sense. Sequioa’s rant to there startups said alot about a leading VC’s character and common sense. They have neither.
VentureLocator.com
I’ve seen him around quite a bit too. Some kind of SEO spammer I guess. Leaving a link trail all over the place.
Maybe there’s a way to nab him on some anti-spam statute? They can get email spammers, so why not comment spammers?
Wow, this is a serious nut case- check out that link that he spams…
“hoovering”??? Meaning “vacuuming” ? Still used in Europe…
Yeah, this douche bag must be eliminated from TC –Mike?
Vacuuming isn’t prevalent in Europe. Instead most of them use hoovering.
I know this is kinda of topic, but since you are alway talking about startups. Can you tell me if I am suppose to get some term sheet or deal paper. Our neighbour kids wants us to angel fund his little company. My wife and i dont see a problem with kicking in 10-20k. Its as risky as the stock market is these days anyway.
Can someone shed some light on what we should get from him. He showed us his presentation today.
Thanks.
Gary, your comment just cracks me up!
why does it crack u up, are u so wise? that beginners asking for honest advice is beneath you?
gary, ill get back to u with some links, just got to get to a meeting now, hold on bro
Can you shed some light on what we should ask him for paperwork wise. I thought this blog had people who followed angel funding etc. We dont know anything about it. We just think about helping out the kid. seems like a cool idea.
Thanks in advance
“Winning Angels” is a good read:
http://www.winningangels.com/
PS. The book is also good for those going after angel funding for the first time.
Will someone please ban all the locator dudes who spam the hell out of every thread lately.
To Gary Sinclear — Don’t do it. Just don’t do it. Hold on to your money, even if it is not a big deal for you to recover it somewhere else.
Most likely, your neighbor’s kids will spend/waste you money on stupid gadgets… The majority of young “entrepreneurs” have, really!, no clue: they dream about Facebook, Youtube, Google, etc. and their millions. The reality is much different.
Then, when the money is gone, you will also lose your neighbors/friends
What the hell is all that stuff around that bear?
The ashes of VC funded companies that didn’t do their homework.
Great article by the way Michael… I might not always agree with you but you do bring a lot of clarifications to the table that are greatly appreciated. It seems everybody wants to blame “others” for “their” lack of action.
Jon
http://WoodMarvels.com - Create Unique Memories
the smart guys right now are all those hubs that only investing 20k per company . y combinator those guy are smart unlike the vc that go all in at once.
Investing 20k per company? Investing 20k what, pogo sticks.
No wonder everything is going to hell. There are only idiots left in the world, and they all seem to have a blog.
Well, couldn’t the bear eat itself for sustenance? How would a startup go about doing this?
Keep in mind that I’m mostly talking about websites here.
I think one of the problems is simply that, in this market, companies without a business model can no longer fall back on advertising/freemium business models. Up until this point companies have been able to burn through cash like it didn’t even matter—because it didn’t. All they had to do was get users. If you had a large enough user base, even without a revenue model, you can always assuage investors with the idea that you can default to advertising. In fact, it’s understood. That’s the only reason that sites like Digg and Twitter exist. Now, I’m not knocking them. I’m just saying that the model they used is not going to be relevant to new commers and those who haven’t already raised significant funds.
I knew the party was over when Google’s stock dropped below $400. In fact, that was the barometer for me, and I have been saying it for a while now. While Google is only a single company, you can think of it as a gauge for what the rest of the world thinks about advertising. A decline in their stock price means that people are having second thoughts about the true value of a company that sells web advertising. The big and traditional players that actually make Google profitable are now strapped for cash themselves, and they too have to start to rethink their advertising budget, model(s), and approach. Gone are the days of companies doing massive ad buys without really thinking about ROI in a truly statistically relevant way. Everyone’s advertising budget is smaller, and companies are really going to have to sit down and think about what they are doing and how they can maximize every last dollar.
VCs didn’t tell people to conserve cash, because they didn’t really have to. Now they do, because the “backup plan”, so to speak, is no longer safe. The big companies are really going to look at what acquisitions give them outside of just eyeballs, and that’s going to suck for the VCs. They want these companies to ride it out. 30m uniques per month isn’t really going to matter if you can’t monetize them in a market that doesn’t value advertising as much as it once did.
IMO, the companies that will survive and thrive are those who actual bring real utility to the world outside of information or simple consumer entertainment laced with advertising. Who is going to die? User companies. Companies that are all about getting users, scaling their application, and then figuring out how the hell to monetize in a scalable way. Those companies are in for a world of hurt.
But what do I know? I’m just an out of work economist.
I think if you look at the advertising/freemium model and equate it to a Radio or TV station it starts to make sense. It is about eyeballs and attention - where it get’s tricky is when you can’t get the eyeballs to look at the ads like in YouTube’s case. I agree with you there is some serious hype going on and the trouble is not all pageviews equate the same amount of action/interaction on the part of the end user.
Google may have had some overvalue in it but the power they have of getting the right eyeballs to the right ads is phenomenal - something that no TV/Radio/Billboard company could ever do. Selling with AdWords is, in my opinion, real selling as in you sell whatever it is you are trying to move, TV’s, Cars, Hotel Rooms - it actually works.
I love your last line - shows that you are open to debate
Cheers - Eric
Aaron, in other words you are just saying that this is the end of the web 2.0, at least of the social-network one, and in general of all those web 2.0 services relying on fremium/advertising model, including some the most successful products of the last years (what about Facebook, you would say that it has a strong business model?)
Obviously the economic troubles are touching every sector and the only entity who’s delusional enough to think they can keep burning through cash is the Bush Administration.
arrington, great post and i agree with your defense of these two irrational arguments, but the real question is how can the VCs expect the same non profitable companies they invested in to become profitable overnight? if we were in boom times and investment was flowing into companies that are 12-18 months from being profitable or worse, never had a plan to be profitable, all of a sudden be profitable? If they invested in companies that didn’t have a revenue model do they expect one to just magically appear now because of difficult economic times?
When i read the dozens of postings this week that is the shocking part. Venture capital, especially in early rounds, isn’t put into profitable companies, but now they want them to become profitable? I can understand how that rattles the core of many entrepreneurs.
They want them to ride out the storm until the day comes again when un-monetized users have value.
I think the more interesting question is why are the VCs publishing their advice to the public? This is quite rare, and kind of weird. I think there’s an ulterior motive.
Fred Wilson himself wrote that his fund will be fine b/c it’s funding sources mainly come from institutions that aren’t especially affected by the down turn. So why exactly will VC money be so much harder to raise? Well because the VCs are telling you it will….. so that they can drive down valuations! and THAT’s what everyone is angry about.
..that’s why theyre fondly referred to as ‘Vulture Capitalists’
Mike,
How can you say point #2 is irrational? You, Heather, Mark, etc. all work out of your house!!
Techcrunch is the perfect example of cutting costs to the bare minimum both in the summer and the winter. And it works great for you… why would you say it’s irrational, when it’s something you practice to your benefit.
not to mention the excessive use of unpaid interns.
actually i was an intern… and we were all paid
Attribution. It is not just profit maximization but also marketshare maximization. Thing is you continue to advocate technology not products & services. VCs, private equity, whatever, no one knows what the future holds - filling users with a willingness to pay us the best start. When you need it, no one wants to give it to you. When you don’t need it, everyone wants to give it to you. Ownership is not in short supply, nor is investment, confidence is what is needed. Where are the leaders?
I think understand the market now.
http://www.oxyshopping.com
The whole bear thing was funny, it kind of goes with “Bear Market”. The point the VC’s are making come from nothing other than EXPERIENCE. As entrepreneurs we tend to think twice as fast and twice as big. Most will also believe that this economic crisis that we are entering won’t last long, so they can’t see the forest that the bear is in for the trees. Earnings will be effected thru ‘09, the average recession lasts for 18 months, some longer. On March 10th 2000, the NASDAQ was at 5132, and the startups of that day and age thought the recovery was right around the corner. Here we are 8+ years later with a close of 1649. It’s going to take earnings to get us back to that 5k number and many startups just don’t have that in their plans. Control, consolidate, or collapse…
Greate post ,i like it!
The 50 word version of this post. By the way, great post.
In your linear programming model, the constraint equations have changed due to indirect consequences of macroeconomic volatility. So the maximal point/plane/topology has shifted. Start ups need to adjust their business processes to approximate the new maximal topology.
Past is gone…companies have to thrive in the present and succeed in the future..
The priority now is to find a way to buck the trend , all possible solutions that could help the tech firms weather the storm.
Some thing like this http://tinyurl.com/48jjjw
Michael,
There is a wee bit of a difference between conserving cash and dancing in Cyprus. Many non-profit companies act like they are already public spending the shareholders money (AIG maybe?).
Michael Kassing
MarkTend.com
I only dance on Martha’s Vineyard. That way I spare myself the costs of crossing the pond. Yeah.
I think the point is you need to be bullish when there is a fair chance to get more funds later should you need them. If everyone is tightening their proverbial belt it is harder to be optimistic and therefore harder to raise your next round.
It is not unlike @gary sinclear up above looking to invest in a friends and family round for 20K. I know I read that and had a knee jerk reaction of - ohhhh you might want to hang on to that cash right now - whereas a year ago I would be yeah for sure go for it. What has changed in a year? The biggest thing is if this young startup does get their product to market there is no guarantee that they will get their next round of funding to take it to the next level. And if it is a truly novel idea their first mover advantage will be stalled because they don’t have the funds to take big scoops of market share - they may go viral but that is not something you can take to the bank.
Cheers - Eric
FORGET ABOUT VCs,WHAT THEY SHOULD HAVE TOLD OR PREACHED….
WHAT IS THE LEADERSHIP/EXECUTIVE /SENIOR MANAGEMENT DOING?
THE TYPICAL PROFILES WITH 20+ YEARS EXPERIENCE ,VETERANS OF SALES,TECHNOLOGY,OPERATIONS AND FINANCE? PEOPLE WHO CLAIM THEY HAVE CHANGED THE WORLD’S LANDSCAPE…INCREASED SALES FROM $20 TO 200 MIL,SUCCESSFULLY LED DOZENS OF M&As…. BLAH ,BLAH…
HAVEN’T THEY FIGURED OUT THE FORMULA YET? OR PRACTISED ATLEAST A BIT OF IT? DO THEY NEED TUTORING ON FUNDAMENTAL FINANCE AND OPERATIONS NOW??????
WHAT ARE THEY DOING IN THEIR MANAGEMENT REVIEWS, OK.WHAT ARE VCs DOING IN THEIR BOARD ROOM REVIEWS?
WEREN’T THEY ASKING THE QUESTIONS THEY ARE PREACHING NOW,TO THEIR STAKEHOLDERS?
Great article. Really great.
“At all times companies need to profit maximize.” Deep from the bottom of my heart, i hope not for all times!
In the coming future of Web xxx.0 we will have the collective networks with the collective knowledge with the collective intelligence leading to a more and more collective understanding, rationality and responsibility.
No more needs for bears bullying around in markets.Thats is what the evolution brought to us and differs human beings from the wild animals. For now, not only the fittest individual survive, but the fittest sociaty. We developed a responsibility not just for us, also for our neighbour and or for our country.
Thanks to radio, tv and the internet many people acting on the behalf of the whole world, fighting poverty, ecological destruction and wars.
Like the fittest cultures long time before, i strongly belief that the in economic and technological terms super fit googles let us take the next steps and bring us to a not so wild and cruel capitalist world with nor more need to always maximize, maximize, maximize.
what?
@Mike: The World cannot change in a week - the markets can driven by speculation. There’s nothing new and surprising and your fellow TechCruncher Erick Schonfeld wrote this four months ago in July. We all knew what was coming, but pretended that this time something will just miss the fan.
I think during recessions Internet companies would actually bloom and be a better investments compared to many other traditional businesses. Ad dollars will be more as consumers will have be stimulated further to spend. People will stay more at home as they won’t be able to afford to go out and will be online more.
VCs do not need to invest “responsibly”, but we all know in boom times they invest in clones of ‘me-too’ technologies that have no value. Is another website by two kids that want to do ‘yet-another-social-network’ to connect flea owners to flea lovers really worth $250-500K in seed? I think not. Telling everybody, including the people that have true revenue models, to ‘get real or go home’ is offensive and arrogant (and I am being polite).
Now for the 2nd argument. Get this once and for all. Startups need to be as thrifty as they can, come rain or come shine. It doesn’t mean they do not have to invest in R&D, PR (when required) and growth. However we all know how people just love going to useless conventions, flying to meetings that could have happen over the phone, and surround themselves with fringe benefits.
So please. Let us, the real people starting new companies, willing to work 18 hours a day even in this climate, spending our own money, not expecting to make a quick buck, work! and stop telling us what to do. We know.
@Doron - Amen! Hopefully the Entrepreneurs like you and I will be able to take some of these lemons and make lemonade
@ MA - While VC’s are certainly not to blame for the downturn they do need to take some responsibility for contributing to it’s future impact. Investing in a company that doesn’t have a plan for generating revenue– or maybe i should say– investing in MULTIPLE companies without a plan, in my opinion, is just plain irresponsible.
Furthermore, this type of funding trend has served only to breed a type of entrepreneur who focuses on the wrong components in building his/her organization. And now as a result, is sadly breeding an organization that is focused only on the “Cash is King” mantra being echoed in the presentations and meetings around the startup community.
In my experience, the majority of the smart and talented business people I know already understand that yes, Cash IS King. But those same people also know that NOTHING significant happens in business until a sale is made.
This past week we have seen VC after VC loudly express financial prudence to their portfolios. But i have to wonder, why there wasn’t this much vocalization about developing a plan for revenue? And if there was, why wasn’t it as headline prominent as we are now seeing with current landscape? Was there any doubt inside these firms that eventually a business without a model for sales wouldn’t end up destined for the dead-pool?
At what point do we hold the free-spending VC’s of the world accountable for contributing to technologies share of mass layoffs, unpaid debts and increase of vacant offices as we move further into this cycle? At some point there has to a be a logical realization that while these risk taker VC’s may not have “caused” any of the immediate economic issues we see — they sure as shit will be a part of it’s end results.
So yea Mike, you may be able to technically say that these arguments are irrational in a cause scenario (and i would agree in some respects). But i don’t think you can deny that the rather large elephant in the room, that no one wants to address, is the misguided priorities behind many of these investments.
Certainly we all make mistakes and VC’s are no different. But as Einstein once said;
” The definition of insanity is doing the same things over and over while expecting different results.”
Maybe this should be the new slide (right before the Get Real or Go Home statement) in their presentations.
Cheers,
ak
Loving the bear analogy!
i wish we all had a crystal ball and knew how bad a downturn we are in for. i got an interesting comment on my blog post that you linked to that is worth reading and following the link in it
http://www.avc.com/a_vc/2008/1.....nt-2999887
I find it odd that the subject of conserving cash and cutting back on expenses needs to be debated. It’s just the logical thing to do. Individuals are (or should be) doing it, so why not startups?
I think web startups (and the entire tech industry) should realize that the credit crunch is actually a blessing in disguise. The web bubble was just about the burst, leaving us techies in a nuclear winter anyway. The credit crisis preempted this bubble bursting, and when it finally blows over our industry will bounce back just like everyone else, without being blotched with yet another major screw-up.
nicely put. timing is everything, and the market is NOT rational. also love the biological analogies, which I put forward (just not as well) recently http://blog.david.bailey.net/b.....ml#1172142
nature has been coping with boom/bust cycles and the real “black swan” events for billions of year, and we need to learn from her.
“billions” of years??? Are you insane???
Hope you include humans on your “nature” concept. ‘Markets’ –including Wall Street respond to human behavior, not your ‘nature’ -
Excellent post.
“Irrational Argument No. 1: The VCs Made This Happen”
…and here I am thinking that it was the Team Cyprus video video that caused the collapse of the world as we knew it…
Good post but I do think cost structures and realistic expectations are always important, regardless of the economic environment. I think many companies out there, both profitable and unprofitable, spend as though there is the all bearing money tree in the backyard (vc’s, credit markets, unrealized monetization) and can be utilized at any time.
For most companies, management should always be thinking like small business owners rather than shooting for the stars. Maximize profits, minimize costs, spend and grow cautiously so that there is always a tomorrow. If your product or service is in demand, the expansion we all seek will be realized. With or without funding, advice or no advice from investors, founders/ceo’s/management are the ones responsible for making their businesses work.
If you cain not beat Obama bomb Iran
If you cain not end the drama bomb Iran
If the markets keep on plunging
time again for emo blunting
never mind about the people - bomb Iran!
Agreed, your SGA has to be tailored to the environment. If you conserve cash during boom times, the competition will most likely blow you away. During recession, competition takes a backset to survival.
The Perfect Storm ahead
Or
The Great Opportunities?
http://bit.ly/2jra6s
During recession people and companies need to revisit their decions they previously took for normal.
Example Up to 2000 Siebel was hot, but afterwards SalesForce took the lead.
For those techies out there, the US economy has turned severely downwards and dragged down the entire world economic systems. Depression 2.0 will be inevitable if the US govt cannot come up with the right policies to combat the frozen credit situation. If you think startups can spend the same as before, keep dreaming! For those VCs, I have said before in TC that I was amazed that “me-too” with no-business-model kept getting funded, especially in the social networking areas. Now the chickens are coming home to roost.
“Me too” blog-wanking-opining around news that has already happened, or been reported upon.
excellent post!
Reserve cash is the #1 priority for anyone right now whether business or personal. It is what makes a company truly healthy or not. To continue to borrow and have a balance sheet with savings on paper and not physically in the bank is just bad business.
http://www.techNmore.com
Dead on! This is what makes Silicon Valley what it is.
For all the detractors of this philosophy (summed up in this article) is there another model that would have created a silicon valley? What would that be? Why has it not happened?
Bad economic times usually means higer likelihood of lower revenues than expected — specially for Ad based revenue models. That in turn means shorter time to refinancing. That means higher the likelihood that VC’s have to reinvest in their portfolio companies sooner — just to keep afloat.
Telling a startup to be frugal, means please don’t all come back right away asking for more money.
http://downturnandstartups.blogspot.com/
Cheers, E
It is simple!
VC encouraged companies to burn money to hot up the market. When the market is cooling down, getting cold and even freezing, companies should get themselves warm only enough to survive.
VC was right encouraging burning money, and is correct pushing companies preserving money.
You simple can not beat the climate.
Every side of the argument has their valid points …
But consider this: If every company AND each of us individually conserved money, the economy will for-sure continue to go down in the dumps and we all would be jobless. When that happens we’re going to be blaming ourselves for telling everyone to conserve.
I have to agree that companies and startups have to somewhat cut-down on costs to survive … but the rest of us in our personal lives have to go out there and spend money on stuff (e.g. Vegas, new car, clothes, fast food, etc.) to get this economy going again.
So who wants to go to Vegas? =)
Certainly does seem like there is a big web 2.0 bubble which we all need to be concerned about. But that that makes it all the more interesting. Everyone has been building in a hope that “they will [then] come”. Just like during the bust, but this time everyone was thinking it is possible to monetize on network effects, on the long tail, by default.
Instead, we all have to think about offering the maximum value to our customers. If the customer benefits, we all benefit in the long term. Nobody can sit in their bubble safely, because it will be prodded at profusely, for some time to come.
Fair enough we cannot blame the VC’s. We cannot blame the Banks, nor the Government(s). We just have to bare the brunt and innovate. Difficult when there is no money, but apparently the best startups are those that rise through a recession. Makes sense when being down and out triggers creativity…
If you believe in your product, have customers that validate your plan, and that represent your mass markets - then the lights are still green if you want them to be. If you are scared, then improve your plans, get a job, or even better blow your savings in McDonalds or Vegas with Jen.
Ps @ Jen - Fast Food Chains will not revive the economy (or your health), nor will Vegas, but passion and innovation just might, right?
I agree. It’s not all doom and gloom out there. The rules of the game have not changed. Maybe this video is an apt rejoinder.
http://sanjaydattatri.blogspot.....there.html
http://in.youtube.com/watch?v=0oQCyBAixEc