Investors: It’s time to get greedy

As I read the 100th news article about the impending collapse in early stage funding, I am reminded of the Warren Buffett quote:

“You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple.”
~ Warren Buffett

I admit taking this stance after my most recent blog, “Early-stage companies, get ready to be punched in the face,” may seem contradictory. However, if you read beyond the title, you would have realized that I was conveying a warning to companies without viable business models, suggesting that now is the time for them to become self-sustainable or risk an early demise.

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To be clear, I believe the current concern around early-stage companies is a good thing long term. Companies with unsustainable business models that were structured and positioned only for the next round are not healthy for the market overall and should not be extracting funding from those with solid business models who solve real problems.

A poor funding environment can be a big positive for the best run companies. These companies will actually benefit in many ways during tighter times.
• They have their pick of hard-to-find top programmers
• They face less competition for good people
• And, as a result, the compensation expectations of that top talent are more reasonable.

Necessity is the mother of invention

Many household public companies were formed during recessions – from companies such as IBM and GE in the late 1890s to Microsoft in the 1970s. More recently, the modern day version of Apple (remember the iPod?) was formed during the very time that the dotcom bubble was bursting in late 2001. Recessions create a sense of urgency and discipline that forces focus and efficiency.

Early-stage companies that are given large sums of capital are often analogous to young kids landing in professional sports. Many of those kids accrue salaries in the tens of millions but end up bankrupt a couple of years later. Just like the young athlete who worked all day to hone his basketball skills to make it to the NBA, the nucleus of young companies is often formed from a couple of students or individuals creating great products in their garages or dorm rooms. Many pundits say they are not surprised when certain pro-athletes go bankrupt after making tens of millions, yet they act shocked when a startup company burns through tens of millions.

Prudent amounts of capital force discipline. Oftentimes, after a large capital raise, young founders go on a hiring spree adding positions across a multitude of departments. This type of non-discretionary hiring is expensive and can damage the company’s underlying culture. It only takes one bad hire to offset tens of great hires.

Lite version of the dotcom bubble

The current environment is a very lite version of the dot.com bubble, that time when companies that should never have been created, e.g. Pets.com and Snowball.com, went bankrupt. These companies would never have been created if not for the bubble. Fast-forward to today when the froth in the seed stage was getting to a point where, everywhere you turned, a friend or neighbor had their own startup and was in the process of putting together a friends and family round.

“We are an Uber for ABC,” was the constant refrain. Oftentimes, these companies were creating solutions in desperate search of a problem. Even when an actual pain point was identified, it was minor or the proposed solution was an inconsequential improvement. Even if they executed, there would be little upside.

Advice to angels and VCs

• Use the current reset as a welcome sign to be more selective and make sure companies you invest in will survive in a tougher environment.
• Make sure management/founders have the wherewithal to function without considerable increases in pay.
• Make sure the company is solving a pain point that will persist regardless of the economic or fundraising cycle.
• Be disciplined about valuation. For instance, public SaaS companies’ valuation has declined from 7x to 4x over the last six months. There should be a corresponding adjustment across all stages of capital raise.

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Then, go ahead and be greedy! Find those opportunities with solid fundamentals – ignore those blinded by fear – and invest.

Josh Burwick is a managing partner at Sand Hill East Ventures. He previously managed technology portfolios at Moore Capital, Pia Capital, and GLG Partners and worked at Goldman Sachs in the technology sector for the Investment Research and Institutional Research Sales departments. He blogs at http://sandhilleast.net/blog.html, and you can follow him on Twitter: @jburwick.