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Slow down hiring! Cut down on marketing! Expand the runway!
Reports of venture capital are back and they are coming in hot.
With technology stocks rising in the first five months of 2022 and the Nasdaq’s rate for the second worst quarter since the 2008 financial crisis, budding investors are telling their portfolio companies that they won’t be spared the consequences and those conditions could worsen.
“It will be a longer recovery, and although we can’t predict how long, we can advise you on how to prepare and move on,” – Sequoia Capital, a legendary venture firm known for its early bets on Google, Apple and WhatsApp. wrote in a 52-page presentation entitled “Adapting to Endurance,” a copy of which was received by CNBC.
Y Combinator, the startup incubator that helped create Airbnb, Dropbox and Stripe, told the founders in email last week that they should “understand that the poor performance of technology companies in the public market significantly affects venture capital investment.”
This is a sharp difference from 2021, when investors rushed into the company before the IPO with sky-high estimates, deals were frantic, and lively software startups made a profit of 100 times. This era reflected an expanded bullish market in technology: the Nasdaq Composite has grown in 11 of the past 13 years, and venture funding in the U.S. reached $ 332.8 billion last year, seven times more than a decade earlier. according to the National Venture Capital Association.
The sudden change in sentiment is reminiscent of 2008, when the collapse of the subprime mortgage market infected the entire US banking system and dragged the country into recession. At the time, Sequoia published a notorious note called “RIP Good Times” in which it announced to startups that “cuts are mandatory” along with “the need to become a positive cash flow”.
Managing Partner Sequoia Capital Doug Leone performs on stage during the second day of TechCrunch Disrupt SF 2018 at the Moscone Center on September 6, 2018 in San Francisco, California.
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However, Sequoia did not always set a time for its warnings. In March 2020, the firm called the Covid-19 pandemic “Black Swans 2020” and urged the founders to abandon marketing, prepare for customers to cut costs and assess whether “you can do more with less”.
As it turned out, the demand for technology was only increasing, and Nasdaq spent its best year since 2009, driven by low interest rates and rising costs for remote work products.
This time, Sequoia’s words are more similar to the common belief in Silicon Valley. The market began to turn in November, and companies that go public will stop until early 2022. Cross-funds, which have fueled much of the private market boom, have retreated, battling historic losses in their government portfolios, Dina Shakir said. , a partner of Lux Capital, which has offices in New York and Silicon Valley.
“Ready for winter”
“Companies that have recently raised estimates at very high prices at the peak of inflation may be struggling with high rates of burns and the rapid challenges that are growing in those estimates,” Shakir told CNBC in an email. “Others who were more sensitive to breeding and decided to lift less may now need to consider options for expanding the runway that would have seemed unpleasant to them just a few months ago.”
In her letter to limited partners for the first quarter, Lux reminded investors that it had predicted such trouble for several months. The firm cited its letter in the fourth quarter, which told companies to save money and avoid unprofitable growth.
“Our companies have heeded this advice, and most companies are now prepared for winter,” Lux writes.
Steady rising fuel and food prices, the ongoing pandemic and fierce geopolitical conflicts have confronted in a way that investors now fear uncontrollable inflation, rising interest rates and recessions simultaneously.
What is different this time, according to Sequoia’s presentation, is no “quick policy solution”. The firm said that in early 2020, it missed the aggressive response of the government, which was supposed to inject money into the economy and keep lending rates artificially low. buying bonds.
“This time, many of these tools have been exhausted,” Sequoia writes. “We don’t think it will be another drastic correction that will be followed by the same rapid V-shaped recovery as we saw at the start of the pandemic.”
Sequoia has ordered its companies to look at projects, research and development, marketing and other opportunities to cut costs. Companies should not immediately pull the trigger, the firm added, but they should be prepared to do so in the next 30 days if necessary.
Job cuts and freeze hiring have already become big stories in major state-owned technology companies. Snap, Facebook, Uber and Lyft have said they will slow down hiring in the coming months, and Robinhood and Peloton have announced job cuts.
And among companies that are still private, Klarna and Cameo are cutting staff, while Instacart is reportedly slowing hiring ahead of an expected initial public offering. Cloud software vendor Lacework announced the downsizing on Friday, six months after venture capitalists valued the company at $ 1.3 billion.
“We have adjusted our plan to increase our runway to profitability and significantly strengthened our balance so that we can be more opportunistic in terms of investment opportunities and uncertainty of the weather in the macro environment,” Lacework said in his blog.
Tomasz Tunguz, managing director of Redpoint Ventures, told CNBC that many novice investors are advising their companies to keep enough cash for at least two years of potential pain. This is a new conversation, and it is accompanied by heated discussions around estimates and combustion rates.
Shakir agreed with this assessment. “Like many, we at Lux advise our companies to think long-term, extend the runway to 2+ years, if possible, look very closely at reducing burns and improving gross profits, and start expecting that in the near future. funding in the future is unlikely to look like they could have expected six or 12 months ago, ”she wrote.
In a May 16 message titled “Reversal Reversal,” Lightspeed Venture Partners began with the words, “The boom of the last decade is clearly over.” Among the subheadings one reads: “Reduce insignificant activities.”
“Many CEOs will make painful decisions to keep their companies afloat in troubled waters,” Lightspeed writes. “Some will face compromises that just a few months ago would have seemed out of place or unnecessary.”
Suite highlighted one of the painful decisions she expects to see. For several companies, the firm said, “donating people will be earlier than donating appraisals.”
But venture firms are trying to remind founders that big companies are coming out of the darkest times. Those who prove they can survive and even prosper when capital is lacking are believed to be able to prosper when the economy rebounds.
For companies that can add talent today, there are more available because of the hiring freeze at some of the largest companies, Sequoia said. And Lightspeed noted that technology will continue to progress no matter what happens in the market.
“Despite all the talk of doom and gloom, we remain optimistic about opportunities to create and invest in technology companies for generations,” Shakir said. “We were delighted to see our CEOs sharing notes and advice with each other, while encouraging and humiliated by these changing conditions.”
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Early investors warn as boom time “definitely over”
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