This Time Will Be Different

Will Price of Hummer Winblad has a good post on how to navigate the coming economic downturn.

He accurately describes what happened in 2001 and 2002:

Valuations seemed absurd in retrospect, companies with no sales were
sitting on $50m-100m post-money valuations, $30m of paid-in-capital,
and absolutely no chance of raising money; save a complete restart. A
collective "what were we thinking" rolled through the valley.

He goes on to tie what may be coming in 2008 and 2009 back to 2001 and 2002:

None of us can predict the markets or future valuations, we all,
however, can understand fundamentals. Businesses that solve real pain
points with disruptive technology, a huge value/price advantage, and a
scalable business model will work – the kiss of death, however, will be
getting the capital structure ahead of those very same fundamentals.
Failure is often a function of too much capital and too high prices
suddenly running into economic expectations that are materially reduced
with respect to market size, market growth, and trading multiples.

To
survive, one may indeed need capital. The trick is to stay lean and not
to overfund and overvalue companies where the investment only "works"
if it eventually trades at 8x revenue and never needs another round of
funding.

It way well be that Slide raising $55m from mutual fund
companies at $500m+ pre-money will be the "what were we thinking"
moment of the current cycle. I think, however, the investor who leads a
$4 on $4m Series A in a company with a differentiated technology and a
direct tie to hard ROI will feel calm in the storm.

I agree with Will that overfunding and overvaluing companies is a bad idea. But I think it will be different this time in a few important ways. I do not think the answer is to rush back to the safe world of enterprise software and infrastructure investments. I do not think we’ll see VCs closing their doors to consumer focused companies.

What I think we’ll see is a flight to quality. Dollars will flow to the established players. If there’s a lesson to be learned from the $55mm round in Slide at $500mm pre, it’s that money right now wants to be with the winners. I don’t think Slide is at all like the companies we were shutting down or recapping in 2001 and 2002. The companies we shut down either had not attracted a customer or user base or had economics that just didn’t work.

So it’s time to assess what is working and what is not working in your business or your portfolio. Focus on the basics. Keep your costs down. Finance your company (or companies) intelligently and most importantly with money that will be around when you are no longer the high flyer darling of Techcrunch.

But don’t look backward for the right model to follow. Look forward.