By Rory O’Driscoll. Source: Fortune.
Anyone who has recently skimmed through headlines about the tech world will find stories speculating whether the industry is about to burst. The latest example comes this month when Birchbox announced that it was scratching expansion plans because it couldn’t obtain enough VC funding, and just announced yesterday another round of layoffs.
If you’re an entrepreneur, the speculation is sure to hit home: Is the bubble going to burst, leaving you without funding? Or will the bubble continue to float along, fueling the growth of tech?
The answer: a bit of both. If you’re an entrepreneur despairing that VC funding is disappearing, take a deep breath. Money is out there — for companies that have the right model. The upshot is that investors are willing to put their money into high-growth companies, but not growth that’s only fueled by overspending. You can no longer grow your business with little regard for the underlying economics. Don’t agonize about the funding climate, but do spend time on creating compelling fundamentals
What’s going on now isn’t a mass slaying of the dotcom crash of the early 2000s, where pretty much everything died. Nor is it an impending shutdown of the funding pipeline, but rather it is a winnowing of who gets the money. What is gone, undoubtedly, is the indiscriminate funding environment of the last few years. The capital markets are doing exactly what they are meant to do, which is weeding out the good from the bad, doubling down on the best deals, and slowing down investments in middling companies and letting the worst of them die.
Some companies will thrive in this environment, and some will go belly-up. Capitalism without bankruptcy, as astronaut Frank Borman said, would be like Christianity without hell. The high-growth/high-valuation/high-burn cycle that was the norm over the past few years simply isn’t sustainable (or realistic, for that matter). The capital markets no longer favor “growth-at-all-costs” businesses. They’re hunting for “good-growth-economics” businesses that have growth, but at a sustainable cost.
We’re seeing this play out across the board. Birchbox just announced it will forgo expansion because it can’t get funding, and One Kings Lane sold for a fraction of its former sky-high valuation, as consumer-facing e-commerce models continue to struggle. At the same time, Demandware, an e-commerce platform that sells to the competitors of companies like Birchbox and One Kings Lane, was acquired by Salesforce CRM 1.08% for more than $2 billion—in the same e-commerce space, but with a vastly different outcome. One model works and the other does not.
The end of the indiscriminate funding environment works in two ways. For loss-making, early-stage companies, capital gets scarce and companies have to scale back plans, or even close entirely. That’s the Birchbox experience: Their management wanted to expand, and the markets said no. They’re not alone. In almost every company in my portfolio, we’re taking a more judicious approach to investment, looking to prune the marginal initiatives (is this really the year to expand in Asia?), while at the same preserving strong investments in the stuff that is working.
For mature, profitable companies, there is no need to raise additional capital. Here, the chill in the air shows up in valuations. A year ago, public market valuations were at their peak, but as a result, technology M&As were few. After the valuation reset earlier this year, technology acquisitions have exploded.
LinkedIn LNKD -0.04% is the poster child for this trend. At its stock’s peak of $255 in late 2015, no acquisition was likely. At its low point of $98, buyers must have come out of the woodwork. The result was Microsoft MSFT 1.05% acquiring it at $192 per share. Demandware, Marketo, Ping, Cevent: The list of recently acquired companies is getting longer and growing as you read this piece. It’s hard to believe venture capital will wilt when, at the right price, smart buyers are willing to buy valuable assets.
It’s important for companies not to overcorrect or slow down growth just because the market is wary. The markets may no longer be willing to fund growth at all costs, but they’re not particularly excited by slow-growth companies either. We recently had a mid-stage private company out raising capital, and the biggest concern from investors was whether the rate of growth at that stage was enough. Investors want to have their cake and eat it, too: high growth along with a clear plan toward profitability. This is exactly what a winnowing process looks like—the bar gets raised, and fewer companies clear it.
So with the right kind of growth, investors will pay attention.