The Bay Area and the broader Tech Industry are currently operating in an inflationary phase. I know you hate the word ‘Bubble’, so I will not call it that, but this is definitely an era of easy money. Eventually, this will shift to a contractionary phase. As I argued earlier (and here), this does not mean a 2002-like crash, but conditions will definitely change. To prepare for this, I think it helps to understand what happens in a downturn. There are a lot of ‘unexpected’ outcomes – seemingly healthy companies can disappear overnight. If I were a CEO of a venture backed company (or advising one), I would want to have a contingency plan ready for the day when the venture spigot gets throttled back, and it would help to know what to watch for.
Recently, I have been consulting with a company about to help them raise a round of venture funding. They have already gone a long way on very little funding, and probably do not need to raise any money. But their direct competitors are raising huge sums, prompting concern that those competitors will buy business and shift the competitive landscape. This is exactly what I was referring to in my post on “The Shape of Bubbles – Ripples Below the Surface”.
When times are good, as they are now, it is ‘easy’ to get things funded. There are a lot of dollars out there going into venture investments. This creates a situation in which there is capital available to companies who would not get funded in a more ‘normal’ environment. This is great for creativity and founders, but it comes at a cost. My favorite example is the on-demand food delivery space. My favorite local Chinese restaurant has gone through three apps in six months. There are probably a half dozen of these companies operating in the Bay Area right now. In addition, several companies in adjacent markets are dipping their toe into the space as well (i.e. Uber). Add another dozen semi-prepared food companies like Munchery. I know that these companies are highly capital efficient leveraging apps, contract laborers and running on AWS. But I see no way they can all survive without regular venture infusions. When analyzed individually, each of these companies may look appealing. They can all argue that they are losing money now to gain share, but they can quickly shift to profitability if needed. But when viewed as a whole set, it is highly unlikely there is room for more than two or three in any region. The whole segment is being subsidized by venture funds. Even if one of the companies claim they do not need any more venture money, their competitors are raising money which they can use to hire more sales people or better marketers or deploy other tools to shift the balance. Eventually Gersham’s Law takes hold and bad money drives out good. Easy venture money is just a form of leverage, and eventually debts have to be repaid.
So the question then becomes who will survive? There is no clear answer to this. Many CEOs I have spoken with are aware that the clock is ticking. They are trying to raise every round of funding quickly to build up a war chest. In the aftermath of the 1990’s dot.com collapse, part of the gloom was caused by the unpredictable nature of which companies shut down. Webvan and Pets.com both raised huge amounts of money (for the times) less than a year before collapsing.
It would be comforting to think that the survivors will be the best-run companies, but that may not be the case. Instead, it is just as likely that the one company to survive any future consolidation will be the last one to raise a real round before times get bad. Personally, I think the right way to think about capital now is to treat venture money like a bank loan. If you think interest rates are going up soon, borrow as much as you can. Six months or a year from now the ‘bank’ may not be willing to make any more loans. And once you have the money, try really hard to ration it out. Of course, if your competitors are spending wildly, this may be painful. Companies are going to need to walk a fine line between the need to stay competitive and the need to hoard some cash for a rainy day.