Something has happened in the last 7 years in the world of startups and venture capital that I haven’t experienced since the late 1990s: We all started praying to the God of Valuation. That hasn’t always been the case, and frankly, it’s taken a lot of joy out of the industry for me personally.
What happened? How might our next phase of the journey look brighter, even with more uncertain days for startups and capital markets?
A LOOK AT THE PAST
I started my career as a programmer. Back then, we did it for the joy of solving problems and seeing something we created in our brains happen in the real world (or at least in the real, digital world). I have often thought that creative endeavors where you have a quick turnaround between the idea and the realization of your work are one of life’s most fulfilling experiences.
There was no money train. It was 1991. There were startups and a software industry, but barely. We still loved every moment.
The browser and therefore the WWW and the first Internet activities were born around 1994-95 and there was a golden age when everything seemed possible. People were building. We wanted new things to exist, to solve new problems, and to see our creations come to life.
And then, in the late 1990s, money crept in, swept into town from public markets, instant wealth, and an absurd skyrocket in valuations based on unreasonable metrics. People were proclaiming that there was a “new economy” and “the old rules didn’t apply” and if you questioned that “you just didn’t get it”.
I started my first company in 1999 and I have to admit I was swept up in it all: magazine covers, fancy lectures, artificial valuations and easy money. Sure, we created SaaS products before the term even existed, but at 31, it was hard to tell reality from what all the wealthy people around us were telling us how good we were. Until we were.
2001–2007: THE YEARS OF CONSTRUCTION
The dot com bubble had burst. No one cared about our ratings anymore. We had nascent revenues, ridiculous cost structures, and unrealistic valuations. So we all stopped focusing on that and just started building. I loved those salad days where nobody cared and everything was hard and nobody had any money.
I remember once seeing Marc Andreessen sitting in a booth at The Creamery in Palo Alto and no one seemed to notice. If they didn’t care about him, they certainly didn’t care about me or Jason Lemkin or Jason Calacanis or any of us. I used to see Marc Benioff in line for Starbucks at One Market in San Francisco and probably few could pick him from a line back then. Steve Jobs still walked from his Waverly home to the Apple Store on University Ave.
During those years, I learned how to build the product correctly, evaluate the products, sell the products and serve the customers. I’ve learned to avoid unnecessary conferences, avoid non-essential costs, and strive for at least neutral EBITDA if for no other reason no one is interested in giving us more money.
Between 2006 and 2008, I sold both companies I had started and became a VC. I didn’t make enough to buy a small island, but I made enough to turn my life around and do some things I loved out of love for the game versus the need to play.
SEE THINGS FROM THE VC SIDE OF THE TABLE
While I was a VC in 2007 and 2008, those were dead years as the market evaporated again due to the global financial crisis (GFC). Barely any funding, many VCs and tech startups crashed for the second time in less than a decade after the dot coms burst. In retrospect it was a blessing for anyone to become a VC then because there were no expectations, no pressure, no FOMO and you could see where in the world you wanted to make your mark.
Starting in 2009 I started writing checks consistently, year after year. I was there for the love of working with entrepreneurs on business problems and marveling at the technology they had built. I realized I didn’t have it in me to be a good player like many of them, but I had the skills to help as a mentor, coach, friend, thrifty partner, and patient provider of capital. Within 5 years I’ve been on the board of real companies with significant revenues, strong balance sheets, no debt, and on the road to some attractive exits.
During this era, 2009 to 2015, most of the founders I knew were building great, sustainable companies. They wanted to create new products, solve problems that had gone unsolved by the last generation of software companies, and grow revenue year after year while keeping costs in check. Raising capital remained difficult but possible and valuations were tied to the underlying performance metrics and everyone agreed that the eventual exit, whether via M&A or IPO, would also be based on some level of rational pricing.
WHEN OUR INDUSTRY CHANGED — THE ERA OF THE UNICORN
Cowboy Ventures’ Aileen Lee first coined the term Unicorn in 2013, ironically to signal that very few companies have ever hit a $1 billion valuation. By 2015 it had come to mean a new era for the market where business fundamentals had changed, companies could easily and quickly be worth $10 billion or MORE, so why bother with the “entry price!”
I wrote a post in 2015 commemorating at the time how I felt about all of this, titled “Why I Hate Unicorns and the Culture They Raise.” I admit my writing style back then was a bit more lighthearted, provocative and opinionated. The past seven years have softened me up and I long for more inner peace, less angst, less outrage. But if I were to rewrite that piece again I would only change the tone and not the message. Over the last 7 years we have built cultures of quick money, instant wealth, and valuations for valuations sake.
This era was dominated by a ZIRP (zero interest rate policy) from the Federal Reserve and easy money in search of high returns and encouragement of growth at all costs. You’ve had access to our ecosystem of hedge funds, cross-over funds, sovereign wealth funds, mutual funds, family offices and all the other sources of capital that drive up valuations.
And it changed the culture. We all began to pray to the altar of almighty evaluation. It wasn’t anyone’s fault. It’s just a market. I find it amusing when people try to blame VCs, LPs or CEOs as if anyone could choose to control a market. Ask Xi or Putin how it’s going for them.
Ratings were a measure of success. They were a way to raise capital on the cheap. It was a way to make it difficult for your competition to compete. It was a way to attract the best talent, buy the best startups, grab the headlines and keep growing your… rating.
Instead of increasing revenues and containing costs and building great corporate cultures, the market has chased valuation validation. In a market that does this, it becomes very difficult to do otherwise.
And the judging party lasted until November 9, 2021. We had lampshades on our heads, tequila in our glasses, loud music and maybe too much sand, and men on fire, art exhibits, and three commas. The hangover was supposed to be burning and last longer and cause some people to stop gambling altogether.
We’re still trying to find our sober balance. We’re not there yet but they seem like signs of sobriety and a new generation of startups that have never had access to Kool Aid.
THE EVALUATION VC GOD
The valuation obsession wasn’t limited to startups. In a world where LPs compare VC performance over a 3 year time horizon from using their fund (your 2019 fund is in the top quartile!!??) you are bound to pray to the gods of valuation. Top right or perish. I see your $500 million fund and raise you with a $1.5 billion fund. On top of that! Ah, 10 billion dollars? Whoa. Hey, we have to raise again next year. We deploy faster!
We were told that Tiger would eat up the venture capital industry because it gave out capital every year and didn’t take a seat on the board of directors. How is that advice holding up?
So now our collective societies are worth less. If we made them public, now we are naked. The tide has receded. If they’re private, we still have fig leaves covering us because some rounds could increase debt over equity or could finance with terms like multiple liquidation preferences or full ratchets or capped convertible notes. But it’s still about ratings and none of that is fun anymore.
A RETURN TO THE AVERAGE
I don’t have a crystal ball for 2023-2027, but I do have some guesses about where the new sober markets might go, and just like in our personal lives, a little less booze could make us fundamentally happier, healthier, for the right reasons and able to wake up every morning and continue our travels in peace and for the right reasons.
I’m enjoying more discussions with startups about the ROI benefits for customers using our products rather than the freshness of our products. I’m focusing more on how to build sustainable businesses that don’t rely on ever more capital and logarithmically increasing valuations. I find comfort in founders in love with their markets, products and visions, whatever the economic consequences. I am confident that the money will be made by people who doggedly and doggedly follow their passions and build things of real substance.
There will always be outliers like Figma or Stripe or maybe OpenAI or the like that create fundamental, persistent, massive change in a market and that reap outsized returns and valuations and rightly so.
But most of the industry has always been created by amazing entrepreneurs who have built out of the extreme spotlight of the industry and have built 12 year “overnight blockbusters” where they wake up and have $100M+ in revenue, positive EBITDA, and the ability to control your own destiny.
I’m having fun again. It’s actually the first time I’ve felt like this in about 5 years.
I told my colleagues at our annual party last week that 2022 has been my most fulfilling as a VC and I’ve been doing it for >15 years and nearly 10 more as an entrepreneur. I feel this way because no matter how many founders get kicked in the shins by the financial markets or the customer markets, I always find a few who dust off themselves, cut their coats to their cloth, and move forward determined to succeed.
Deep down I love working with founders and products, strategy, go-to-market, financial management, pricing, and all aspects of building a startup. I suppose if I loved spreadsheets and valuations and benchmarking I’d be working in the even more lucrative world of late-stage private equity. It’s not me.
So we’re back to building real business. And that personally brings me much more joy than obsessing over ratings. I am confident that if we focus on the former, the latter will take care of itself.
Photo by Ismail Paramo on Unsplash