March 2021 marked the one-year anniversary of the first Covid-19 lockdowns. The world was, to put it mildly, tired. People needed hope, and so, they looked back into history, with many storied publications drawing parallels to the last major disruptive global health event: the Spanish Flu Pandemic of 1918.
Although similarly disruptive as Covid, this moment led to the so-called Roaring Twenties—a period of economic growth, liberation and creativity. Many hoped that Covid would lead to an equally energetic and prosperous period.
Suffice it to say, things didn’t work out that way. For investors, particularly those in the capital-hungry world of technology, times have never been tougher. The 2010’s tech bull run was largely driven by the post-2008 interest rates, which incentivized institutional investors into making more ambitious bets and pushed company valuations into the stratosphere. That bull run is now over.
Yet despite this undeniable adversity, there are still opportunities to be found. Yes, fund sizes are smaller. Venture capitalists must now operate with a level of caution that they didn’t previously. Until tech stocks recover, exits will be inevitably smaller, meaning many businesses are patiently waiting to go public.
All those things are true. But that doesn’t change one unassailable fact: People are still making great products, with the potential for long-term growth and profitability. Rather than hunker down, now is the time for investors to strike deals. We’re in choppy waters, and only those with vision and confidence will thrive.
Invest For Sustainability
At the start of 2022, the top of the federal funds target range was a mere 0.25%. By this February, that hit 4.75%. For investors, that’s obviously bad news. As one study shows, for every additional percentage point increase in interest rates, investors’ ability to raise capital drops by 3.2%.
As a result, VC firms are struggling to attract as much cash as before. Compounding problems further, we’ve seen a widespread drop in tech company valuations.
Naturally, many businesses are delaying their IPOs and waiting for the market to eventually recover. For those institutional and high net worth investors that traditionally fill VC war chests, this means they’ll have to wait longer for a return on their capital—and that return may be smaller than what they were once accustomed to.
With limited capital, VCs must make difficult choices about where to invest. The era of backing high-growth companies—businesses that grow for the sake of growth and pay little concern to profitability—is over.
As the era of cheap money fades, it’s time for investors to focus on sustainability, market fit and businesses with a low cost of customer acquisition. In pitch meetings, investors must strike a more inquisitorial tone. Before they open the checkbook, they must ask tough questions:
• How much capital do you need?
• How long will it take to reach sustainability, and how will you get there?
• How long will it take for you to become profitable?
• What are the features and strategies that will help you reach those milestones?
And founders must have credible answers.
Invest For Solutions
It’s ironic. Inflation is a major factor behind the crisis VC faces. But it also presents genuine opportunities for investors.
Inflation only has two remedies. The first is to raise interest rates. Over time, that strategy works, but it has a terrible cost. Businesses and consumers cut back. People lose their jobs. Companies stop—or slow—hiring.
A better way is to increase productivity. When workers produce more, the human cost associated with a product or service drops, and companies can afford to lower or maintain prices, thus calming inflation.
Naturally, businesses and governments will increasingly look for products and tools that can help them raise productivity. It’s worth noting that some of the most successful B2B companies—like Yammer, New Relic and Expensify—all emerged in 2008 during the global financial crisis, when interest rates reached worryingly high levels.
It’s also worth pointing out that governments are investing heavily in infrastructure that can help productivity. The U.K., for example, offers generous tax cuts for those building gigabit broadband networks. In some cases, startups can supplement their VC capital by taking advantage of tax incentives and subsidies, which is incredibly helpful, given the decline in VC funding rounds.
Don’t Forget The Consumers
During tough economic times, consumers tighten their belts. Mired in uncertainty, they look at ways to cut nonessential spending. That was true in 2008, giving rise to companies that addressed this reality.
Groupon, founded just two months after the collapse of Lehman Brothers, let people buy cut-price vouchers for restaurants and consumer goods. Uber, founded when the U.S. unemployment rate was 8.5%, was a cheaper alternative to traditional taxis and allowed ordinary people to make money in the sharing economy.
Although both companies have made their own missteps in the years since, their original concepts were both valid and timely. Investors should be on the hunt for businesses that serve a similar purpose. Companies that let consumers spend less or earn more will inevitably thrive during this period.
Stay Positive, Even When Silicon Valley Isn’t
Times are tough, but it’s worth looking at the current moment from a historical perspective. Interest rates are high, but they’re no higher than in late 2006. Despite the high-profile layoffs at industry behemoths, the labor market remains strong. Inflation is now easing—particularly in the U.S.
If investors treat this moment as the crescendo before a systemic economic collapse, they’ll miss out on opportunities. And that’s because, it most likely isn’t, in my opinion. It’s a moment of post-pandemic adversity, fueled by unforeseen events such as the war in Ukraine. Like all bad moments, it will pass.
Chon is the founding partner of Berkeley SkyDeck Fund and an experienced Silicon Valley engineer, entrepreneur and investor.
Source: Investors Shouldn’t Let A Good Recession Go To Waste
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