If you graduated from college in 2009, you have never known a bear market. For your entire adult life, interest rates have been at 0%. When I was 18, I borrowed money in a student loan program. I could borrow back then (1980) at 3.5%. I didn’t use the money for school. I put it in a money market account and got 20%.
You read that right, 20% short term 3 month bills.
Back in 1982, you could have tied up money for 30 years at interest rates between 10-12%. My first house had a 12.5% mortgage in 1988. When I bought my seat, I paid a point over the prime rate, 9%.
We are living in extremely unnatural times when it comes to interest rate policy.
If you are running a startup, there is still time to prepare yourself for the coming tidal wave. The wave is building. It’s out on the ocean right now. My gut tells me the Federal Reserve will not move rates at all this year, or perhaps only a token .25 of a point. But, when they start moving the capital markets will move much faster and far ahead of the Fed.
As rates change, risk/reward ratios that have been out of whack for a long time will start to readjust. The ability to raise capital might become impinged. It’s extremely hard to predict what will happen in the broader markets and economic environment: deflation? inflation?. No one really knows and the predictions from economists are about as good as the projected financial statements I see with every startup presentation.
As a CEO of a company, you need to start building a culture that doesn’t focus on the company’s valuation. Focus on the customer. Focus on effort, and hitting small goals that take you to larger ones. It could be very likely that many companies will face down rounds of financing when the tidal wave hits. Down rounds can be tough on employees and morale.
The other thing startups need to do now is figure out how to get some revenue. Top line revenue can put a band aid on a big burn rate. Having a consistent source of revenue when the wave hits will help you tell a better story to investors who likely will be sitting on their hands. They will be scared, and revenue helps loosen their wallet.
Cutting your burn rate is imperative. Knowing where to cut is the trick. Every business is different and as CEO, it’s up to you to figure out what is fat and what is not. Starting to think about these kinds of decisions now will prepare you and the team for it. When you cut employees, you might figure out a way to offer them a way to purchase their options. That brings cash into the company. When Groupon ($GRPN) went from 8 to 4, the 4 that were let go were given that opportunity. It worked out really well for the ones that took it.
Valuations at seed are extremely high to me. It’s pretty hard to justify them. I have been told by people that “it’s the market”. I get it. Few people investing in startups “get” markets like me. Friends of mine that are VCs are saying later stage valuations are too high as well. That’s caused by too much money chasing too few deals.
When I hear stories of the square foot cost of San Francisco/Silicon Valley real estate, the cost to hire people and other stories; I want to figure out how to “short” it.
When times of stress appear, liquidity dries up. One of the things I learned when I was trading is that when the shit hits the fan, it’s pretty hard to unload a big position and you have to pay through the nose to do it. I remember I was in a 1 year calendar spread. It was around 1988. It was illiquid, and only two or three people made markets in it. On a Friday, I was long and the spread got destroyed. I couldn’t get out at any price; so I had to keep the position on and “wear it” over the weekend. On Monday, one big buy order came into the market. I was the only market maker that day. The market was still very illiquid, and I was fortunate that the large order moved the market all the way back.
I found that in 1999-2001, discipline won. I remember meeting the CEO of some internet storage companies that had outrageous P/E’s and stock prices in triple digits. They were on pink sheets after the market cracked. We are going to find out who has it, and who doesn’t relatively soon.