Sequoia Capital’s “R.I.P. Good Times” deck made the rounds on the web last week. It’s Sequoia’s take on what happened with the economy and what their portfolio companies should do to weather the storm.
What was their advice before the downturn?
The analysis is good and the advice sound, but it also begs the question: What was their advice before the downturn?
Now they are saying you should:
- Control spending
- Throttle back growth assumptions
- Cut earnings assumptions
- Focus on quality
- Lower risk
- Reduce debt
They also say that you “need to become cash flow positive” and “spend every dollar as if it were your last.”
So what was their old advice? Did they encourage their companies to spend more than they had, skimp on quality, grow grow grow, take on more risk, and accumulate more debt?
Was being cash flow positive not a favored strategy before the downturn? If it wasn’t then, when was it going to be? If you weren’t in a position to make money when times were good how are you supposed to be in a position to make money when times are bad?
“Good Times”
Another thing I want to take issue with is this notion of “good times.” What was so good about the times a few months ago or even a few years ago for these companies? If you had to keep borrowing to stay afloat, were those good times? If you were running a business with no revenue coming through the door, were those the good times? If you were hiring more people than you really needed, where those the good times? There’s nothing easier than spending other people’s money. So fun and frivolous times, maybe, but good times, no.
Monday morning analysts
One of the things that always bugs me about downturn analysis is how the “experts” always seem to be a day late. After the missed earnings call or the market downturn the analysts come out and downgrade a stock or sector or market. So they miss their earnings number on Monday and on Tuesday you’re telling me to sell the stock? What’s expert about that?
This Sequoia deck gives me the same feeling as the stock analyst who screams “SELL” after the gloomy numbers go public. Good advice comes before the bad times roll, not after. Anyone can look back at an event and dole out sound advice after it happens. The people worth listening to are the ones who were giving the good advice before it was fashionable.
Jeff Gardner
on 13 Oct 08So true, I thought the same thing when I watched the presentation. If you’re business idea can’t produce positive cash flow – you should probably rethink your “business idea”.
SuperB
on 13 Oct 08The goal of most venture funds has never been to create great products, or create a great place to work. The goal is to provide maximum ROI for fund investors. Enlightened VCs understand that both can be accomplished simultaneously, but most simply lack the vision and leadership to make it happen. I’m always surprised with how many VCs simply follow the crowd…
The real irony – If a start-up actually accomplished what Sequoia suggests, they would not need a VC at all…
Chas Grundy
on 13 Oct 08Does Sequoia invest in companies who play it safe? Most likely, they want companies in their portfolio who take risks and have the potential for major growth. So this advice, a year ago, might have been foolish – too risk averse. At least, in their model. It’s just not the 37signals model.
J
on 13 Oct 08You can take plenty of risks and still be cash flow positive. The idea that “risks” means “no revenues” is ridiculous.
Joran
on 13 Oct 08Jason, thank you. You’ve nailed it. And Warren Buffet was giving the good advice well in advance: http://www.berkshirehathaway.com/letters/letters.html
Paul Graham
on 13 Oct 08See slide 46.
Don Schenck
on 13 Oct 08Well, I put off the 3-Series purchase until next year :(
Tony Wright
on 13 Oct 08Sequoia’s advice makes sense. And different advice from them in happier financial times ALSO MAKES SENSE.
In a happier financial times, customers are flush and buying. Buyer confidence is high. Growth is easier, your sales/marketing spend can be a touch lower, etc.
In happier financial times, VC-backed startups can count on more investment if they are generally moving in the right direction. Whether you think VC-backed startups are stupid or not, that’s how the game they are playing works. Funding in a down market is scarce and terms are rougher.
In happier financial times, VC-backed startups have a better shot at an exit (IPO, M&A). Again, whether you think it’s stupid or not, that’s the game.
No VC (good times or bad) cousels startups to waste money, but in a good market you can certainly have a better shot at winning and winning bigger by spending your money in leveraged way (trying to spend $1 to create >$1 in value). For companies with good products/growth, this isn’t that risky because more money can be raised with good terms.
In a down market, it becomes more about survival and waiting for times to be better (for fundraising, exits, and sales).
In the world of sustainable businesses, obviously having different strategies in different markets makes less sense. In the Sequoia world (like it or hate it) it makes perfect sense.
condor
on 13 Oct 08slide 46 seems to say the trade off is to preserve capital vs. grabbing share. I don’t understand why they have to be mutually exclusive? Why can’t you grab share in a profitable way, by making more than you spend, and so achieve both goals?
Edwin Khodabakchian
on 13 Oct 08Hi Jason,
I think that you are missing the point. The advice given here is that the recovery is going to be slow and long (not a V shape but more of a U or an L) and therefore the companies should not focus as much on growth but instead that try to reduce their burn rate to maximize the probability that they will still be standing when the recovery happens.
I think that you look too much at the world through the 37 signals viewpoint: it is great that you could bootstrap and build a sustainable business but not all business opportunities are alike: some businesses need to invest a lot in R&D before they can build their product. Some businesses need to invest in a salesforce to sell their product. Some businesses need cash flow to grow from 20 people to 200 and 2000 people.
I usually like your posts but you sound a little too arrogant on this one.
Raul
on 13 Oct 08Now they are saying you should:
...
So what was their old advice?
Maybe the point was why they were discussing it?
condor
on 13 Oct 08Fortunately for software companies R&D can be invested at the margin. Its not like capital expenditures where you need the entire loom in your warehouse before you can start making fabric, with software you can develop and prove as you go. Upfront investment is needed, but it can be managed on the margin. It usually isn’t, but it is very possible to do so.
Above all other parts of a company, a salesforce can be manage on the margin to covers its costs. Sales compensation should be weighted heavier on the variable side, which means that ‘investment’ can easily be managed to be profitable at the margin.
Why grow to 20 or 200 or 2000 people if the business can’t afford it, ie it needs to finance those heads? Why not hire as needed and when you can afford.Keith Williams
on 13 Oct 08This is an un-equitable apples and oranges comparison.
Historically, the VC game in Silicon Valley start-ups is all about quick ROI and market dominance for either a public or private liquidity event.
37Signals is playing a different game that, prior to the Bezos investment, was largely about organic growth.
A Soros vs. Buffett comparison is apt. They both have the opportunity to create wealth, but use very divergent strategies.
I’ve been on SvN for years and this post is so extremely uncharacteristically daft. Were it authored elsewhere, I would suspect link-baiting motivations. Sad.
Mike Rundle
on 13 Oct 08Keith: So now that 37signals has the Bezos investment, you’re saying that they’re not growing organically? Well you must be seeing a few dozen new faces around Signal vs. Noise that I’m not seeing because I’m not seeing this inorganic growth you speak of. I think they’ve only hired a few people in the last year or two and only after they really needed it.
Narendra
on 13 Oct 08Jason, you forgot to get in a jab about all that chart junk in that presentation.
Seems like it could have been reduced to one slide.
Do you have a real business? If yes, grow it wisely. If no, enjoy your death spiral ride.
Anonymous Coward
on 13 Oct 08Jason I am with you on this one. The point where our world and the VC’s worlds are colliding is the assumption that in the ‘good times’ – as in tons of cash on the market – you have to go all out to grow as fast as you can and trump everyone else in terms of eyeballs, users, development and marketing power etc. While that might be true for the one in a million next Google it is harmful for the average start up and it is almost a certain death sentence for many me too companies that jump onto a boom trying to create another youtube.
The – go for it while you can – approach obviously works for (some) VC’s, otherwise Sequoia & co wouldn’t be around for a while now but two things are easily forgotten during the ‘good times’:
1) Hundreds of start ups implode for one of them to become the jackpot
2) VC’s get payed no matter if your start up evaporates or if it exits successful
Last but not least: VC money doesn’t want to be ‘in bed’ with your company forever. They’re looking for an exit to make money quick. Since the markets are down exits are closed for now. So it makes total sense to slow their portfolio down to build up until the doors for profitable exits open again.
Ultimately you have to know what you are doing and what you want when you decide to go for VC. You have to look at all possible scenarios beyond the ‘good times’ when it’s fun to look through the pink ‘spend other people’s money’ goggles.
Peter Urban
on 13 Oct 08Sorry the above post came form me. Somehow I’ve missed to fill the contact fields – maybe to much Thanksgiving going on here in Canada … ;-).
Keith Williams
on 13 Oct 08@Mike Rundle
No. As far as I can tell, 37Signals, to their credit, has not strayed from their knitting. It’s still a firm dedicated to organic growth and smartly leveraging, and re-leveraging, capital into hosted subscription-based Web products. For the record, I’ve been a Basecamp subscriber for years and was a fan of their minimalist design motif when full-page image-maps and splash screens were considered “smart” web design.
The Bezos investment was, as far as I know, the first significant 3rd party private equity stake the firm ever took. This was a significant departure from previous financing stratagems. Again, all I know is what was in the news.
Jason may wish to chime in w/o revealing any confidential specifics, but I highly suspect the Bezos deal terms memo would be anathema to the typical silicon valley VC firm like Sequoia, Greylock, or Benchmark.
One other point worth mentioning is the historic focus of silicon valley on capital-intensive business models. People forget, though started in a garage, many of these tech business plans demand large capital infusions before even a model, let alone a reality, of sustainability can be achieved.
Look at the early days of Cisco (packet-switching), HP (electronic instruments), Fairchild (integrated circuits), and even Google (search via datamining). It took a $100k check from Andy Bechtolsheim to even begin to start productizing Google’s search indexing technology. It’s a different game.
bernardlunn
on 13 Oct 08Jason, I agree and have been banging the same drum on ReadWriteWeb (and via comments on Fred Wilson’s blog). 37 Signals is rightly the most admired of a new breed of SAAS ventures that does really need less capital, not just to get to launch but also to get to profitability. But 37 Signals is far from the only one of this new breed and we are planning profiling as many as we can find on ReadWriteWeb. At the same time I am finding a real dearth of profitable VC backed companies. This is a problem for VC funds (and their investors, which to a large degree is the rest of us via Pension Funds). The VC model applies well to building new semiconductor chips or alternative energy or a cure for cancer. It is simply wrong for building most web sites. Bernard PS, loved your talk at Web 2.0 New York
Joran
on 13 Oct 08Re: most of the above comments:
The point is that venture capital played a large role in contributing to the culture of excess that is in part responsible to the current “crisis”.
The lines of thought are certainly similar: “here, you too can have a bond. Oh you can’t pay for it? No problem, we’ll figure that out later, we’re almost certain the market will grow”.
Sound familiar? “Here, have some money, oh you’re not seriously a real technology company? No problem, you look cool though and we’ll just hire some programmers”.
For advice like this, at such a time, to be coming from venture capitalists, is, to be frank, rich. So much for foresight.
And anyway, it’s possibly the wrong advice.
Then again, VC’s like picking up deals on the cheap. What better time?
J
on 14 Oct 08I think that you look too much at the world through the 37 signals viewpoint
37signals’s viewpoint is mainstream majority business viewpoint. That is, build a company that sells a product and makes money. It’s what people have been doing for thousands of years.
The VC/Sequioa viewpoint is the rose colored glasses viewpoint.
Mattijs Naus
on 14 Oct 08Couldn’t agree more! And I am really surprised how many apparent believers in the Silicon Valley way of doing things (get funded, forget about profits, give away free stuff instead and get as many eyeballs as possible) are getting in defense mode (have a look at the discussion at news.ycombinator.com).
Any entrepreneur acting outside of the ridiculous SV sub-reality, would agree that all measures mentioned in the presentation fall under common business sense, regardless of the current economic situation.
CrisisOfFaith
on 14 Oct 08Sounds to me like it’s a trippy wonderland out there in VC country: spend other people’s money, don’t have to make any real money, code until something interesting bubbles up. Seems their supply of Kool-Aid is threatening to dry up, and they’re looking at the real world, all up close and ugly.
James
on 14 Oct 08Jason, you made some pretty good points; especially calling into question the expertise of the experts who just tell you the obvious after the fact.
One thing I feel I (as a half-trained philosopher) have to point out: ‘begs the question’ doesn’t mean, ‘leaves unanswered’ or ‘invites another question’; it means that an argument or line of reasoning takes for granted the very thing which it’s trying to prove.
http://en.wikipedia.org/wiki/Begging_the_question
Daniel Gibbons
on 14 Oct 08Generally I agree, particularly because most, if not all, of the web 2.0-style start-ups have zero chance of becoming a Google, Amazon or eBay. However, Sequoia’s model has worked for them—deploying very large amounts of capital by small business standards and generating truly epic returns for their funds.
Even though Google rose through the first dot-com collapse, it would, in retrospect, have been very foolish of them to prioritize making money in the short term over investing large amounts of capital in the future.
But in the end, 99.99999% of “idea companies” simply aren’t going to be a multi-billion dollar mega hit, so all the energy and talent would be far better directed into building much smaller businesses that solve today’s problems and generate cash flows as soon as possible.
Joe Ruby MUDCRAP-CE
on 15 Oct 08Financial “experts” explain things after the fact…film at eleven…
Samer El Sahn
on 15 Oct 08Sorry, but this is a very superficial analysis to the presentation.
It is very clear that what they were advising in this presentation
1. be aggressive in cutting costs 2. Don't invest in growth, or improvement 3. Don't make long term money generating projects 4. don't be tolerant to money dwelling activities/projectsNobody said that the 37 signal model wrong which is generating an OK amount of money from day one (and yes I know how much you make and it is still considered OK beside other companies that accepted investments). But still It is not wrong to have the money to invest for long term projects that will generate lots of money in the future.
It is the market Dynamics that proves the second model right, or else this model would have collapsed a long time ago. Investors are not fools to put their money in place that will not return back anything. Actually they all got rich from doing so.
If Google didn’t have sequoia then it would have remained in the basement.
As the only standing example, 37 signals still amazes me, is it because of rails, is it because of the team, the connections in the community. 37 signals seems to be the only company making that much money. Could you name a number companies that does the same, and generates that much good money?
Raza
on 16 Oct 08is off-shoring going to be silver bullet for this problem ? It might not be, but it will definitely help reduce operational costs for these startups.
www.confiz.com your offshore development partner
This discussion is closed.