What Sequoia Capital’s “Black Swan” Memo Means for Unicorn-Hotspots Like San Francisco, Silicon Valley & Others
“False optimism can easily lead you astray and prevent you from making contingency plans or taking bold action.”
By Wolf Richter for WOLF STREET.
Sequoia Capital, one of the most prominent and most experienced venture capital firms that has seen its share of blowups, sent a “Black Swan” memo to the founders and CEOs of the startups it is funding. Back in 2008, as the Financial Crisis was starting to take stuff down, it had put the founders and CEOs of its portfolio companies through a presentation, titled “R.I.P. Good Times,” with the purpose of preparing the leaders of these startup companies for what was to come so that their companies could survive. This time, the memo, published on Medium, is titled: “Coronavirus: The Black Swan of 2020.”
This may not be a “Black Swan” for the economy overall, but it’s likely a Black Swan for the current startup universe that is populated by prodigious cash-burn machines.
The memo provides “guidance” on how to run a startup so it can survive the business and economic challenges posed by “the spreading effects of the coronavirus.”
The guidance is the opposite of what many unicorns and non-unicorns that grew up on the notion of endless cash want to hear. And it shows that there are big changes afoot that will impact unicorn-breeding grounds such as San Francisco, Silicon Valley, San Diego, Boston, Seattle, Austin, and many others.
So I’ll start with the section further down in the memo, because it tells you that they mean business, and that things need to happen quickly, and that other things are already happening quickly, whether anyone wants them to or not, and that startups need to adjust to them or die:
Having weathered every business downturn for nearly fifty years, we’ve learned an important lesson — nobody ever regrets making fast and decisive adjustments to changing circumstances.
In downturns, revenue and cash levels always fall faster than expenses. In some ways, business mirrors biology. As Darwin surmised, those who survive “are not the strongest or the most intelligent, but the most adaptable to change.”
And you know what’s coming: Six points on how to survive by a mix of cutting expenses, cutting headcount, cutting advertising, and cutting capital expenditures to preserve cash – and by getting ready for the end of easy-endless-funding and preparing for a tough slog going forward.
Get ready, cut expenses, preserve cash.
1. Cash Runway. Do you really have as much runway as you think? Could you withstand a few poor quarters if the economy sputters? Have you made contingency plans? Where could you trim expenses without fundamentally hurting the business? Ask these questions now to avoid potentially painful future consequences.
The money is going to dry up. Deal with it.
2. Fundraising. Private financings could soften significantly, as happened in 2001 and 2009. What would you do if fundraising on attractive terms proves difficult in 2020 and 2021? Could you turn a challenging situation into an opportunity to set yourself up for enduring success?
Many of the most iconic companies were forged and shaped during difficult times. We partnered with Cisco shortly after Black Monday in 1987. Google and PayPal soldiered through the aftermath of the dot-com bust. More recently, Airbnb, Square, and Stripe were founded in the midst of the Global Financial Crisis. Constraints focus the mind and provide fertile ground for creativity.
Prepare to survive tough sales.
3. Sales forecasts. Even if you don’t see any direct or immediate exposure for your company, anticipate that your customers may revise their spending habits. Deals that seemed certain may not close. The key is to not be caught flat-footed.
Cut advertising and marketing expenses.
4. Marketing. With softening sales, you might find that your customer lifetime values have declined, in turn suggesting the need to rein in customer acquisition spending to maintain consistent returns on marketing spending. With greater economic and fundraising uncertainty, you might even want to consider raising the bar on ROI for marketing spend.
Layoffs – now before you run out of cash.
5. Headcount. Given all of the above stress points on your finances, this might be a time to evaluate critically whether you can do more with less and raise productivity.
Be prudent with capital spending.
6. Capital spending. Until you have charted a course to financial independence, examine whether your capital spending plans are sensible in a more uncertain environment. Perhaps there is no reason to change plans and, for all you know, changing circumstances may even present opportunities to accelerate. But these are decisions that should be deliberate.
In other words, discipline.
The fake halo of the unicorn with its fake “valuation” that was used to generate hype and create and even bigger “valuation” no longer matters. Cash is going to be tight, and startups will run out, in which case they will collapse, no matter what their “valuation” is.
To survive, they need to bring costs down, cut expenses, trim headcount, reduce capital expenditures, slash marketing expenses (much of which is wasted anyway), and prepare for tough times:
A distinctive feature of enduring companies is the way their leaders react to moments like these. Your employees are all aware of COVID-19 and are wondering how you will react and what it means for them.
False optimism can easily lead you astray and prevent you from making contingency plans or taking bold action. Avoid this trap by being clinically realistic and acting decisively as circumstances change. Demonstrate the leadership your team needs during this stressful time.
A shakeout is already underway.
Numerous startups, approaching the out-of-money moment without new funding in sight, have shut down or laid off a bunch of their people. This started last year, well before the coronavirus was even on the horizon. And now the coronavirus issues are thrown on top of it. For startups, this confluence is a Black Swan event.
And it’s going to get rough for unicorn-breeding grounds so uniquely focused on startups, like San Francisco and Silicon Valley, that they derive a significant part of their economic activity from the startups, the billions in investor cash they throw around locally, the billions in cash their employees throw around locally, the taxes they all pay, the homes they buy or rent, and the offices they lease. It’s all going to change.
There will be fewer companies, and the survivors aren’t going to throw around cash like they did before, and there will be fewer employees to throw around cash and buy or rent homes, and there will be fewer billions to go around. And suddenly, there will be all kinds of vacant office space, and folks looking for jobs, and homes on the market, and landlords trying to find tenants. The unicorn bubble has burst – that’s what this means. There will be startups that survive this, some of them will thrive, and there will be many others that will disappear.
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