January 30, 2023

Something happened in the last 7 years in the startup and venture capital world that I hadn’t experienced since the late 90’s – we all started praying to the God of appreciation. It wasn’t always this way and frankly it took me a lot of pleasure in the industry personally.

What happened? How can our next stage of the journey look brighter, even with more uncertain days for startups and capital markets?

A LOOK BACK

I started my career as a programmer. Back then, we did it for the joy of solving problems and to see something we created in our brains realized in the real world (or at least the real, digital world). I’ve often thought that creative endeavors where you have a quick turnaround between ideation and realization of your work is one of the more satisfying experiences in life.

There was no money train. It was 1991. There were startups and a software industry, but hardly any. We still loved every moment.

The browser and thus the WWW and the first internet companies emerged around 1994-1995 and there was a golden period when everything seemed possible. People were building. We wanted new things to emerge and new problems to be solved and our creations to come to life.

And then, in the late 1990s, money started creeping in, dragged into the city by public markets, instant wealth, and absurd skyrocketing valuations based on no reasonable standards. People proclaimed that there was a “new economy” and that “the old rules didn’t apply” and if you questioned it, “you just didn’t get it”.

I started my first business in 1999 and admittedly got swept up in all of this: magazine covers, fancy conferences, artificial valuations, and easy money. Sure, we built SaaS products before the term even existed, but at 31 years old, it was hard to delineate the reality of what all the money people around us were telling us we were worth. Until we weren’t.

2001–2007: THE YEARS OF CONSTRUCTION

The dotcom bubble had burst. No one cared about our ratings anymore. We had burgeoning revenues, ridiculous cost structures and unrealistic valuations. So we all stopped focusing on this and just started building. I loved those salad days when no one cared and everything was hard and no one had 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 would see Marc Benioff queuing for Starbucks at One Market in San Francisco and probably few could get him out of a line. Steve Jobs was still walking from his home on Waverly to the Apple Store on University Ave.

In those years I learned how to build good product, price products, sell products and serve customers. I learned to avoid unnecessary conferences, avoid non-essential costs, and aim for at least a neutral EBITDA when for no other reason than no one was interested in giving us more money.

Between 2006–2008 I sold both companies I founded and became a VC. I didn’t make enough to buy a small island, but I made enough to change my life and do some of the things I loved for the love of the game versus the need to play.

SEEING THINGS FROM THE VC SIDE OF THE TABLE

Although I was a VC in 2007 and 2008, those were dead years as the market evaporated again due to the global financial crisis (GFC). With almost no funding, many VCs and tech startups collapsed for the second time in less than a decade after the dot com burst. In hindsight it was a blessing to anyone who became a VC at the time because there were no expectations, no pressure, no FOMO and you could figure out where you wanted to make your mark in the world.

Starting in 2009, I began writing checks consistently, year after year. I was in it because of the love of working with entrepreneurs on business problems and marveling at the technology they built. I realized I didn’t have it in me to be as good a player as many of them, but I had the skills to help as a mentor, coach, friend, frugal partner, and patient funder. Within 5 years I was on the board of real companies with decent sales, strong balance sheets, no debt and headed for some interesting exits.

During this era, from 2009–2015, most of the founders I knew were building great and lasting companies. They wanted to build new products, solve problems that the last generation of software companies hadn’t solved, and grow their revenue year after year while keeping costs under control. Raising capital remained difficult but possible and valuations were tied to underlying performance metrics and everyone accepted that the eventual exit – via M&A or IPO – would also be based on some level of rational pricing.

WHEN OUR INDUSTRY CHANGED—THE UNICORN AGE

Aileen Lee of Cowboy Ventures first coined the term Unicorn in 2013, ironically to indicate that very few companies have ever achieved a $1 billion valuation. By 2015, the market had entered a new era where business fundamentals had changed. Companies could easily and quickly be worth $10 billion or MORE, so why worry about the “entry price!”

I wrote a post back in 2015 reminiscing how I felt about all of this at the time entitled, “Why the fuck I hate unicorns and the culture they breed.” I admit that my writing style was a bit more carefree, provocative and idiosyncratic back then. The past seven years have softened me and I long for more inner peace, less fear, less resentment. But if I were to rewrite that piece again, I would only change the tone and not the message. Over the past 7 years, we have built cultures of quick money, instant wealth, and valuations for the sake of valuations.

This era was dominated by a ZIRP (zero interest rate policy) of the federal reserve and easy money looking for high yields and stimulating growth at all costs. You had access to our ecosystem of hedge funds, crossover funds, sovereign wealth funds, mutual funds, family offices and all the other sources of capital that drove up valuations.

And it changed the culture. We all began to pray to the altar of almighty appraisal. It was nobody’s fault. It’s just a market. I find it funny when people try to blame VCs or LPs or CEOs as if anyone could choose to control a market. Ask Xi or Putin how they are doing.

Ratings were a measure of success. They were a way to raise cheap capital. It was a way to make it hard for your competition to compete. It was a way to attract the best talent, buy the best startups, make headlines and grow your… rating.

Instead of growing sales, keeping costs down, and building great company cultures, the market was chasing valuation validation. In a market that does this, it becomes very difficult to do otherwise.

And the appraisal party lasted until November 9, 2021. We had lampshades on our heads, tequila in our glasses, loud music and maybe too much sand, and burning men, and art exhibits and tres commas. The hangover would no doubt be searing and last longer and lead some people to stop playing the game altogether.

We are still trying to find our sober balance. We’re still here now but I seem to be showing signs of sobriety and a new generation of startups that never had access to the Kool Aid.

THE VC APPRECIATION GOD

The valuation obsession was not limited to startups. In a world where LPs benchmark VC performance over a 3-year time horizon from someone’s fund’s deployment (is your 2019 fund in the top quartile!!??), you are beholden to praying to the valuation gods. Up and to the right or perish. I see your $500 million fund and I pick you up with a $1.5 billion fund. Top that! Oh, $10 billion? Wow. Hey, we have to raise again next year. Let’s implement faster!

We were told Tiger would eat up the VC industry because they put in capital every year and don’t take any board seats. How does that advice hold up?

So now our collective holdings are worth less. If we made them public, we are now naked. The tide has gone out. If they’re private, we still have fig leaves covering us as some rounds can raise debt versus equity or fund with terms like multiple liquidation preferences or full ratchets or capped convertibles. But it’s still about valuations and none of that is fun anymore.

A RETURN TO THE CENTER

I don’t have a crystal ball for 2023-2027 but I do have an inkling of where the new sober markets may go and just like in our personal lives a little less alcohol can make us fundamentally happier, healthier and for good reasons and in able to wake up every morning and continue our journeys in peace and for the right reasons.

I enjoy more discussions with startups about the ROI benefits for customers using our products rather than the coolness of our products. I enjoy more focus on building sustainable companies that don’t rely on ever-increasing capital and logarithmically rising valuations. I take comfort in founders who are in love with their markets, products and visions, regardless of the economic ramifications. I am convinced that money will be made by people who frugally and stubbornly follow their passions and build things from real content.

There will always be outliers like Figma or Stripe or maybe OpenAI or something like that that drive fundamental and sustained and massive change in a market and collect outrageous returns and valuations, and rightly so.

But the majority of the industry has always been made by great entrepreneurs who build on the industry’s extreme spotlight and build 12-year “overnight successes” where they wake up and $100 million+ in revenue, positive EBITDA and an opportunity to be in control their own fate.

I’m having fun again. It’s really the first time I’ve felt this way in about 5 years.

I told my colleagues at our annual holiday party this past week that 2022 has been my most fulfilling year as a VC and I’ve been doing this for > 15 years and almost 10 more years as an entrepreneur. I feel that way because no matter how many founders get kicked in the shins by the financial markets or by customer markets, I always find a few who dust themselves off, cut their jackets to their size and continue 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 liked spreadsheets and valuations and benchmarking, I’d be working in the even more lucrative world of late-stage private equity. It’s just not me.

So we’re back to building real businesses. And I personally enjoy that much more than the obsession with ratings. I am confident that if we focus on the former, the latter will take care of itself.

photo by Ismail Paramo On Unsplash

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