Stock Market Drops. Then It Rallies. What Happens Next for Funding?

Posted on Aug 9, 2011 | 29 comments


This article was originally published on TechCrunch.

Venture Capitalists typically have partners’ meetings on Mondays. Why is that? Who knows. But probably because as a group we travel a lot. So the industry formed around a day of the week when all partners could avoid having company board meetings or traveling.

Yesterday was a Monday. And not a pleasant one.

Rewind. When I first got into the industry it was 2007. Valuations were enormous relative to progress in companies. Web 2.0 was still a term being bandied about. Companies with less than $2 million in revenue were asking for $50-60 million valuations and getting them. My partnership was pretty bearish and scratched our heads a bit at price tags.

It was a great learning time for me. I spent my days meeting companies, figuring out what areas of the market interested me and trying to get a sense for how VCs thought about fair valuations. I thought about things I never had to as an entrepreneur: check size, ownership percentage, deal stage, portfolio construction and risk.

2008

By 2008 I had gotten more serious about championing companies through our investment process. I started showing my partners more deals that I found interesting and doing loads of analysis on the future of markets I thought were ripe for disruption.

I have always believed that TV was ripe for disruption. The parallels to the music industry are too obvious even though the industry players, the medium and the cost structures are different. US TV advertising is $60 billion in its own right. I had found my industry and a deal I really liked in it.

I introduced my partners, we spent weeks with the team and felt good rapport. And just when I thought I had the deal that was worthy of bringing to investment committee the world changed. It was September 2008. The market had tanked. Lehman Brothers had filed for bankruptcy. It was many events that led to the crash but perhaps this was the pin that pricked the market.

The following is a 2-week graph of the end-of-week price of the Dow Jones Industrial Average (DJIA) in Autumn 2008.

And while the market was off 24% in two weeks, it’s worth remember 2 other things

  • The market was actually off 40% from its Oct ’07 peak
  • The market wouldn’t bottom until Mar ’09. On Mar-6 it hit 6,626 or 53% off its peak

We thought the following:

  • No new deals close until we figure out WTF is going on with the market. We need some visibility.
  • Let’s review all of our existing investments. Let’s make sure each has enough cash. Cut where needed. Finance where needed. Anyone not going to make it?
  • Who has deals in process? Let’s help get their funding get finalized or the company sold if it’s already in play.
  • Fawk, man. This is really bad. Depressing. Harrumph.

It felt awful. Kind of like you felt as personal investors, no doubt.

My deal got dragged out and eventually never happened. Mostly we got to see the team operate in stressful times and that changed my perspective on the deal. I need leaders who manage in good times and bad.To build a large company you need to manage through economic cycles.

2009

Come 2009 we felt really bullish about the future for startups because the froth was gone and so, too, were wantrapreneurs. The people left standing had a compelling vision to build companies and we backed many in 2009.

When this period was fresh, in Sept 2009, I wrote a very detailed assessment of what I thought had just happened.

tl;dr summary

  • Companies raised too much money in 2005-08 and had high burn rates
  • VCs were very active in this period
  • When the market tanked they had the “triage problem” – which portfolio companies to save, which to kill
  • So no new deals got done. Everybody focused inwardly
  • And VCs scrambled to raise their own funds. Making even less time for new deals
  • VCs hate downrounds to even good companies struggled to raise money
But
  • Eventually you have to invest. It’s your job. You don’t get paid to sit on the sidelines. So when the market started showing good signs (iPhone, Facebook, Zynga, Twitter, stock market growth) it was happy days again
  • M&A returned. For the same reasons. You would think it would be better for M&A to be more active when the markets are down – better prices. But I guess you could say the same about VC.
So I encouraged entrepreneurs to think about raising their funds as quickly as they could because
  • Consumer spending 70% of the economy and vulnerable (wealth effect, build up debts)
  • Unemployment likely to rise
  • Risks of these two factors to the stock market
  • Stock market declines would bring back dog days of VC

The full articles are linked below. If you want a comprehensive summary of the industry in this era it’s worth a read:

VC Ice Age Part 1 – What Happens When a Market Comes to a Standstill?
VC Ice Age Part 2 – Why the Market Started Moving Again?
VC Ice Age Part 3 – What The Future Holds

In particular part three talked about what happened if we saw a double dip in 2010-11 or a “lost decade.”

2010

We did not. Fundings boomed. 2010 was the year of the “super angel” and 2011 has to date been the year of unbelievably highly priced B,C & D rounds of venture capital. The so-called “billion dollar club.”

Fast forward a year to September 2010 and I wrote my treatise on the 2010 economy. It has some detailed charts you may appreciate if you’re wanting to understand the current economic situation. I show charts on housing, structural unemployment, home equity re-financings that we spent meaning less spending power post crash, new housing sales, debt-to-income ratios, public-sector job problems that will cause crises in cities and states across the US.

Summary version? No chart was good.

At least you can’t accuse me of being inconsistent. My year-over-year summary sounds very similar upon re-reading them.

2011

I have a young entrepreneur friend who IMs me a lot. He was working on a VC round in the early Summer. He pinged me for advice. I told him (verbatim), “close your round by August 2nd. After that, all bets are off.” He’s literally on IM right now in my other browser tab saying, “you called it.” I can’t say his name yet because he hasn’t announced funding. But he got it done. Maybe he’ll reveal our conversation when he announced.

August 2011. What’s happening?

The fundamentals in our economy are mostly not on more solid footing than when I wrote the posts in 2009 and 2010. On the positive side, corporate profits are up, their balance sheets have been repaired and they have recapitalized themselves to have lower amounts of debt relative to equity. Not just tech companies but industrials, too.

But you’d have to be a pretty heads-down coder to not have noticed the past 2+ weeks in the DJIA.

Most of the informed people I know are telling me that the sharp sell-off has more to do with European national debt (PIGS as it is called: Portugal, Italy, Greece & Spain) than the current US dilemma of a S&P downgrade of the US government debt. But it must also be on the minds of investors that perhaps the flu will end up on our shores, too.

I know that investors must also be aware of the civil unrest in the UK. Yes, it seems to largely be thugs. But social unrest is created in harsh economic times and we’ve seen this in Greece before. Expect it to spread. It does weigh on the mind.

And while I cannot tell you for sure what was going on in VC partner meetings across the world today – I’m a data point of exactly one – I think I have a pretty informed guess. And depending on which way that economy heads I can tell you what the story in entrepreneur land *might* be in 60 days, “funding is getting harder, valuations are slipping, companies are running out of cash, M&A is slowing down.”

So let me give you the news 2 months early. If the economy and the stock market continue to languish that’s exactly what’s going to happen.

I’ll bet most partners’ meetings this week consisted of looking just a little bit closer at the cash needs of their portfolio companies – making sure they’re “fully funded.” I’ll bet many of them did a review of their “investment pace” as in – how quickly should we be investing. I’ll bet many did a slow roll on deals that might have gotten approved today. Not a “no” but not yet a “yes.”

It’s impossible to sit in a partners’ meeting on a day like today without having an iPhone on watching the stock market free fall and no matter how much of a public tech cheerleader you are – privately I guarantee there was much concern.

If we do head South it will take a few weeks or months until the memos to portfolio companies get published and the Powerpoint presentations get sent out. But the internal conversation started today – trust me. VCs will take a “wait and see” approach right now. Don’t want to call it either way. It’s too early.

Me? I feel confident telling you to, “Watch your pennies. Raise your money. Don’t spend like it’s 1999. If we’re not heading for a double dip recession at least you’re still being prudent.”

Maybe we’ll bounce right back? Anybody who says they know for sure one way or the other is a bit of a shaman. But I have to imagine the speed and severity of the stock market decline and political instability will likely weigh on investors for some time to come – even if we rebound.

[Update: I wrote this post for TC yesterday. Obviously the market rallied today on news from the Fed. I’ll cover this in my next post. Hopefully tomorrow. Here’s the graph for the books.]

I’ll tell you what still worries me: Jobs, growth & political malaise. And don’t think tech will remain immune.

I guess that’s why I encouraged people to raise money while the getting’s good (PPT slides & video).

My prognosis?

1. Jobs
I’ve been parroting this for 2 years. We have a two-track economy. We have the inability to hire engineering in Silicon Valley or brand sales people in NYC but the country still has very high structural long-term unemployment. Check out the graph below from the Economist magazine. It plots employment changes from the peak GDP quarter of the previous boom. What you’ll see is that it takes about 2 years to recover jobs from the normal recessions of the past 50 years (as if there was a “normal.”)

This recession?  We’re 2.5 years in and still down 5% from the peak.

What gives? I’m guessing many of these jobs ain’t coming back any time soon. The last big recession was in the early 90’s where IT and globalization were in their infancy in terms of impact. We need a plan to replace these jobs long term. That can only come through education, training and investment in regions of the country that are not IT centers.  There’s no band-aid solution and no quick fix.

Whatever you think about tax policy, I’m certain that it’s not driver one way or the other to fixing this problem. Anyone who says it is a driver is selling you political malarky.

We gotta fix jobs.

2. Growth
The story here is no different.

My message to entrepreneurs has been, “It’s coming soon to a theater near you.” You know – the “butterfly effect” on a local and tangible basis. Consumers hurting in Detroit or Biloxi will not continue to spend money they don’t have and income they’re not earning. It will impact retail. It will impact brands. These companies advertise. On your tech platforms. These consumers buy iPads, iPhones, Androids. You’re counting on them for up-sells to your app. For buying virtual goods. You need consumers – they’re 70% of the economy.

Trouble is – they don’t have jobs. Those that do still have too much debt. Their 401k ain’t what it once was and it just got whacked again. They still have too much personal debt. And the equity in their house isn’t rising. They’re doing what economists call “de-leveraging,” which means spending less, saving more.

And you don’t see it. You don’t see it because the world you likely live in if you’re reading this has been booming. And even if you’re not physically in a booming tech market you’re likely in the market spiritually, metaphorically. You’re reading TechCrunch, aren’t you?

3. Political Malaise
I think here I’ll just quote myself from my analysis a year ago to avoid sounding like I’m jumping on the bandwagon of this week’s quarterback analysis:

“While there was a momentary unity in the US government for bailouts & stimulus spending that were initiated in the Bush administration (many people conveniently forget this now) and continued under Obama, it is clear that this era of consensus is over.  Keynesians will argue that this is a bad thing and fiscal conservatives will argue that it is a necessary discipline. 

Either way, the gridlock that is now the US congress will prevent any real economic responses and it seems likely that this political malaise will last beyond the 2012 election as the Republicans look to make big gains in the 2010 mid-term elections.”

Maybe the stock market drop will bring some clarity to congress. Maybe it will bring some bi-partisan spirit to solving the nations problems. Maybe. But evidence seems to the contrary. Right now people seem to be angling more around November 2012. And that sure sounds a long way away to me.

What does this mean for the tech and VC markets?

I’m characteristically still bullish on our long-term trends for companies who get through the toughest times. Here’s what I know:

  • Television will be consumed dramatically differently in 10 years from now than it is today. Creative destruction will continue to create opportunities for people who understand the deflationary economics of the Internet. I’m long.
  • Cash will continue to become less relevant in 10 years as electronic & mobile commerce continue to proliferate and new technologies like NFC drive change. I’m long on payment technologies.
  • Computing will be an order of magnitude more mobile 10 years from now, changing the way applications are delivered and the way we interact with our real social networks. I’m long Mobile. And Social.
  • Businesses will continue to realize that the Internet is one big information utility and will continue to move operations to the cloud. This will create whole new segments of the tech market for databases, data-as-a-service, real-time information processing, cloud mapping & visualization technology, etc. I’m long the cloud.

Venture capital is an industry best served up from 7-year aged casks. As many people have said, “We over-estimate the impact of technology in 3 years and under-estimate the impact in 10 years.”

Make sure you’re still here in 10 years. Get yours. Then go build your companies.

Top image courtesy of Fotolia.

  • Anonymous

    An experienced and successful angel gave me two pieces of advice on this. He said: 1) don’t just sit out a bear market: if you do, your deal flow dries back up; and 2) 25k is the new 50.  I don’t see the total shutdown, but it’s a slow road out there. Not altogether unhealthy, but besides seeing a lot of middling VCs dropping out from lack of funding, I’m guessing you’ll see far fewer accelerators and new angels 24 months from now. Great post as always.

  • Anonymous

    Mark, Are these hype cycles all that good for entrepreneurs? After the hype is over, wanna be entrepreneurs give up and leave, investors loose, and good startups loose too, while the opportunity of the internet is not any less. There is real value to be created. Do you think more value has been and is being created this cycle, more companies with solid revenue, so if there is a shake-out to happen, it won’t be as severe?

  • http://twitter.com/samhickmann Sam Hickmann ✔

    That’s a really good post. Congrats!

  • Laurent Boncenne

    Mark Suster, back to his blogging roots! Thanks for a great read!

    As a french, i’m curious to see what that’s going to mean on our side of the ocean (in 3 years, 10 years). I really hope these various events don’t affect entrepreneurship over here.

  • Dave W Baldwin

    Great Post! 

    I hope today’s (the 10th) movement is minimal (+/- 50 range) so that the bigger population doesn’t panic and we can smooth things out this week.  We desperately need to avoid the losses everyone experienced ’08-’09 since that is the only way to gain whatever amount of consumer spending. 

    On the jobs side, it is as simple as companies have found how many workers they need to fill the orders.  I saw where the “1 million robots in China” headline did create a splash.  Though robotics on the line has been around, that headline represents a change from position of overseas jobs filled by underprivileged to mechanical.  Looking forward to 2013-15, we cannot think in terms of tarrifs forcing transfer of human labor from overseas back here.  Doing so just leaves us drowning.

    On that note, new industry (coming to every politician’s neighborhood) is NOT going to be the factory full of $20-50/hr employees and last. 

    That is why my position has been related to not trying to pit one neighborhood against another.  If we can drive innovation across the country, using multiple beehives as the metaphor, we open opportunity and achievement.  That is the only way to lift the greater number of boats avoiding the envy scenarios politicians will continue to rant about.

  • Leah Yomtovian Roush

    Mark, it seems unlikely that  “the sharp sell-off has more to do with European national debt (PIGS as it is called: Portugal, Italy, Greece & Spain) than the current US dilemma of a S&P downgrade of the US government debt.”  Europe’s debt issues are not new news.  I would argue the downgrade was the root cause of the sell-off. And yet, investors still have faith in U.S. long-term debt as demonstrated by their pouring of money into the debt. Investors are anxious but they still choose to take cover in the U.S. dollar.

  • http://twitter.com/idealsam Sam Bell

    Perhaps VCs needed a reminder that there’s a fair level of risk in a lot of these deals (particularly these tech startups that aren’t really doing anything). That said, in any market VC would still be at the top of my list of favourite investments. Investing in and then helping grow a fledgling business is still one of the best routes to decent capital growth.

    Slightly o/t but as a small business owner that also does a bit of stock trading it’s almost always far more profitable for me to spend the day working on my business than trading. Maybe I should be a better trader…

  • Pete Griffiths

    Great post, Mark.

    IMHO we are witnessing the consequences of a long term shift in economic power.  Since WWII all a guy had to do to have a higher standard of living than his parents was (i) finish high school (ii) don’t do drugs (iii) don’t get your high school sweetheart pregnant. (literally!  they studied it).  Why was this true?  Why did we have it so good?  Because the US had enormous structural economic advantages over all other countries.  We were not only the world’s leading industrial power, we had a huge lead.  This lead meant that we had a lot of ‘margin’ in our system and this margin was fat enough to cover up a lot of inefficiencies – notably in our political institutions and associated social bargains (welfare, health…).  The change that hit Europe earlier and is now hitting the US is the growing economic power of Asian economies.  As they develop and move up the value chain they are putting huge pressure on our economy.  This competition is cutting so deeply into what was our lead that in many areas there is no margin left to finance the inefficiencies that we ‘disguised’ for so long.  This has huge knock on effects.  The economic pressure has created a pressure to revise longstanding social contracts (notably spending on social welfare) but there is huge pushback from those ‘entitled’ to the benefits of such spending.  And this is the point where our political system kills us.  The very checks and balances of which we are so proud makes it impossible for us to respond effectively to the challenges we are facing.  The recent debt ceiling fiasco is simply an acute instance of a systemic problem.  Politicians and ‘Washington’ are blamed but what we actually have is long term shift in economic hegemony with an associated institutional crisis.  The likely outcome is that we will have an intensification of what you call the two track economy.  The high value added tech sector will do great and the ups and downs of the financial circumstances will have short run impact only.  The low value added sectors will suffer as will our social fabric.  Social explosions such as the recent blowups in the UK will likely be repeated not just across Europe but in the US.  Our political system is likely to prove itself more impotent than ever.  Short term fluctuations notwithstanding the outlook for tech is great.  But the environment of which we are a part is unlikely to feel as comfortable and stable. This lack of a warm and fuzzy feeling about the whole society should not however neuter our commitment to plough forward building cool stuff in the tech world. We can withstand these ups and downs.

  • http://twitter.com/#!/Mr_RamV RamVaz

    I totally agree.  Well written.

  • Anonymous

    Mark: 

    Great post. We read the same tea leaves as you, so we just closed an insider round last week.

    At the same time, we’re thinking more of building a great privately held company vs a publicly held one. I believe more and more startups need to think about modeling themselves  as sustainable private enterprises, more like SAS, Sungard, or Bloomberg than Groupon or Twitter. Here’s our blogpost on the matter:

    http://www.buzzient.com/blog/2011/08/when-the-going-gets-tough-the-tough-stay-private/

    Keep up the insightful posts; they’re great reading!

  • http://twitter.com/BusinessPartnrs Business Partners

    “Cash will continue to become less relevant in 10 years as electronic
    & mobile commerce continue to proliferate and new technologies like NFC drive change. I’m long on payment technologies”.  Also other forms of currency other than cash will be on the market. Agree though on mobile money taking center stage.

  • http://twitter.com/timbarnes10 Tim Barnes

    Very insightful.  Thanks!

  • erdal

    hello mark and everyone,
    because of my poor english language maybe i might misunderstand you.so i am asking:
    1. for the future nearly  3 to 10 years you think
    a. telecommunication companies worth investing
    b. internet companies worth investing
    c. venture capital companies worth investing (in my country we have such companies which invest money in different but profitable developing companies, or buy such companies not profitable but they then make them profitable)
    d. i dont know what “the cloud” and “payment technologies” mean……
    2. for the developing countries like mine (turkey) or brazıl, can you say the same thing..
    thank you very much.

  • Dave W Baldwin

    Good read re private vs. public. 

  • http://lmframework.com David Semeria

    PIGS – Portugal, *Ireland*, Greece and Spain.

    Italy is a real oddball. Given the sins of the past it at one of the highest debt / GDP ratios on the planet. It’s still well over 100%.

    But Italy also has one of the highest *primary* surpluses in the world.

    In other words, if it didn’t have to service and repay all that debt, Italy would be AAA+++++

    Go figure.

  • http://sco.tt Scott Yates

    Mark, there’s one question that I can’t get out of my head:

    If it sucks to be in the Dow, then wouldn’t a rational response be: “Maybe I should look for something else to invest in.”? 

    I mean, other than people wearing tinfoil hats, we can’t put all our money in gold. Banks are fine for holding money with no gains at all. Why aren’t investors looking for ways to invest in startups? Everyone says that’s the thing that’s going to get the freaking economy going again, why not invest in them?

    I think I know the answer, it just depresses me to think about it.

  • http://www.homethinking.com nikiscevak

    Mark, an excellent post – all your fundamental analysis is great, your read on the wider psychology of other investors is spot on… but then you’re conclusions/own actions seem to totally out of whack.

    Hold off on the investment when the Dow crashed? Make more investments when the market decided to get more positive but when the fundamental charts stayed the same? “Wait and see” what happens? 

    Seriously, if you are ‘waiting and seeing’ in times of turmoil then you will miss the best time to show your convictions around longer term trends and technology change and get rewarded for it. As Warren Buffet said “be fearful when others are greedy and greedy when others are fearful”.

    Shouldn’t you be licking your lips at the chance to fund companies at valuations that will inevitably revert to their longer term mean? The next few years will likely offer you the chance to define your investing career now you’ve gotten comfortable in the role.

  • dt

    Actually, tax policy is very much about jobs. Maintaining govt ability to spend means public sector jobs, service/product procurement, cheques to the jobless and medicine orders for the elderly. This spells multiplied economic benefit to many people, companies, sectors, States and even countries. Tax policy is important, believe it.

  • Mat Tyndall

    Good to hear that you are still long on mobile, social, cloud. After reading everything else it was reassuring to see that show of confidence at the end.

    The historical trends are definitely scary for a lot of companies, but I prefer to think that this will (to mix my metaphors) help thin the herd to make it easier to find diamonds in the rough, good thing I’m one of a kind. 

    I’ll probably need to stay lean and mean for longer than I’d prefer, but I can deal.

  • http://twitter.com/twiterqueen86 Stephanie Persells

    I love reading about the ups and downs of the stock market.
    A great way to get information quickly. Thank you so much.

    http://www.stocksnsectors.com/

  • http://thesistown.com/ thesis

    poor man on the photo! he looks so tired!

  • Jack

    Here you go.

  • Jamie Dick-Cleland

    Really insightful post, many thanks, food for thought.
    Only bit missing was ‘I’m long education’!

  • http://ror-e.com David Henner

    Great post.  Is raising money with an OK demo now better than raising money with a ready for productions demo in 2 or 3 months?  I’m debating this with my business partner.  

  • http://www.plugandplayegypt.com Roham Gharegozlou

    What a great post – I don’t know how you find the time for such insightful pieces AND a day job.. Thanks for this great article and many more before it. One potential piece that doesn’t fit in your model: assuming the IPOs of FB, GRPN etc go alright (big assumption), and even if they don’t, you’re still dealing with a new class of young millionaires starry-eyed to make their first angel investment… Do you think the public market downturn will be enough to dissuade the LinkedIn / Facebook / Groupon / other millionaires from investing as angels? 

  • http://twitter.com/EyeOnJewels EyeOnJewels Corp.

    Great, timely post Mark.

    On the jobs issue my experience points to the current education
    system.  In my experience trying to work with a few Southern CA public colleges and universities the systems are extremely slow to move/innovate and practically closed to change (lip service is live and well though).

    I would add this to your list of industries that will (have to)
    be disrupted significantly in the next 10 year cycle.  The current
    dinosaur system will kill the economy here if not changed, soon.  Most
    of the investment and innovation has been in the delivery but the
    biggest challenges are in funding/cost and the programs.

    Darius

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  • Ryan Clarke

    I agree as well, for both authors.

    Mark’s piece is spot on for the tech community but it is as relevant  
    to the rest of people who don’t read TechCrunch or have iPhone. Consumption is the fundamental basis of our economy. Absent jobs there is  no consumption and no economic growth(basic math). The joblessness  numbers bandied about say sub-10% but I call “bullsh!t”. I lived in NYC and saw more like 20%+ among professional friends and that number isn’t getting much better except if you work in financial services.  Imagine what the job situation looks like for my non-professional friends: just as bad, if not worst.

    There are some serious social problems facing America if the economic  
    disparity isn’t addressed soon. In the NYC tech scene, and probably  
    across the country, there is a shortage of engineers and therefore low  
    un/underemployment. But that is not the situation facing most of  
    America so please take off the rose goggles and see what’s happening  
    around you. First comes the increase in muggings for iPods and  
    iPhones, then break-ins and finally the riots as experienced in the  
    UK. My father lives in London and personally visited some of the  
    neighborhoods damages by the riots. By his account most of the goods  
    stolen or shops ravaged were for items popular among young people:  
    mobiles, sneakers(trainers), clothing and electronics(flat screen TV’s  
    etc.). Most of the stores that didn’t carry these products were left  
    untouched, even if they were literally next door.

    Pete’s summary is spot: the outlook for tech(and financial services)  
    is good….the rest of American society, the other 98% of the  
    population….not so good.

    Think of it this way: what good is a new iPhone 5 if you can’t walk  
    around with it in public? That’s where we are headed if we don’t  
    reinvigorate our economy soon.

    (pounded out in the dark on my iPhone so please excuse any typos)

  • Ryan

    Good blog post, specifically your thoughts on TV consumption 10 years out. Where do you see pockets of disruption for innovation – on the content or distribution side? Some combination? Will AAPLs of the world ultimately capture all of the value here, or are there opportunities for VC financed startups? Thanks for the post!!! I enjoy your blog.