Is Winter Coming? Does it Matter?

December 27, 2019

Recently, a good friend sent over the TechCrunch article "VC's Urge Their Portfolios to Prepare for Winter". Obviously, I'm new to this and as an operator have only known a bull market, but I suspect some market cyclicality will be introduced in the infancy of my investing career.It's important that I'm thinking about the potential impacts while researching lessons from past economic downturns. I figured it would be worthwhile to share a snapshot of my response to the article above as it highlights my thinking.We went through something similar at Choose Energy, but instead it was a VC specific cooling off. Our Series C closed in 2015 and our leadership team anticipated the market could not stay as active as it had previously been.While the decrease wasn't as strong as anticipated, it did happen - YoY total deals declined by about 15% in 2016. As a result, we raised a bit more than needed at a strong valuation allowing us to extend our runway through 2016 and eventually increase our operating leverage which also led to profitability.This was also part of our thinking with our investment in WNDYR, we saw a strong services business that would be the backbone of a company as the software gained traction. Additionally, the efficiency gains they bring to businesses will become more important both to SaaS companies and startups looking for efficient growth as well as large firms looking to be more productive with fewer resources in the event of an economic downturn.During the last recession, venture funding fell by 50% nationally in Q1 2009 from Q1 2008 to a total of $3.9 billion and continued on that trend for the remainder of the year. 2009 was the lowest total funding since 1998, yet here's a small sample of firms close to an IPO and founded during that time:Airbnb (8/2008)Uber (3/2009)Slack (2009)Cloudflare (2009)Pinterest (2009/10)Lesson: the bear market can be a good time to invest if you are focused on building long-term value and expect your holding periods to be on the longer end, especially since you’ll see less yield everywhere else. Good companies are still founded during recessions.Obviously, we think industrials are well suited for this shift as the larger companies usually shy away from startups that don't have a path to a strong balance sheet. The flip side is that there have to be levers that allow that to happen. If you aren’t acquired, those levers can still be pulled if capital becomes less readily available.Lastly, it's possible the startup capital crunch could be smaller than anticipated if the downturn is a short one, though I'd advise startups to plan on the opposite.Currently, there's still a lot of dry powder on the sidelines from all of the mega funds VC firms have been raised ahead of the slowdown that's supposedly been on the horizon for several months now. They’ll be in a great position to follow on to good deals if pricing decreases due to a cash crunch and startups should be aware of this in the event funding slows for a while.

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