Over our Brightspark history of nearly 20 years, we have witnessed a few slowdowns – the “big one” was the first Internet market meltdown in 2001, followed by the 2008 financial crisis, and a few other highs and lows on this rollercoaster ride.
At times like these, we have learned how to best look in both directions. First, we face our portfolio companies and make sure they are thinking about what a potential market slowdown would represent for their business. Then, we face our investors and work with them to be ready and think about how to best react.
No one is sure whether a market slowdown is imminent or not. The reality is that sooner or later though, the market will turn, and we have been in the current bull market for nearly 10 years - the longest run in history. In the near future, we may experience some small corrections or bounces which typically do not affect the early-stage tech market. But, when a big correction happens, usually all asset classes are affected, including venture capital.
The good news? In previous recoveries, we have seen that early stage tech companies that can survive hard times create significant value.
Lessons learned: How we check-in with our portfolio companies
Do they have a “must-have” product?
As VCs, when we choose which portfolio companies to invest in, we often draw an imaginary line that marks the divide between “need to have” solutions and “nice to haves”. When there is a downturn (especially in the corporate/enterprise world), CFOs are tasked with managing expenses, and the non-essential projects are first to get cancelled or get cut back. That’s why we feel strongly about investing in companies that are developing indispensable solutions, and we’re quick to reject superfluous products.
How much capital do they need to survive?
The greater the times of uncertainty, the more we encourage our portfolio companies to raise some extra capital. In most cases, surviving a downturn mostly comes down to having enough money to make it through the tough times. So, while we usually encourage our companies to raise enough money to “reach a milestone”, during uncertain times like these, we also encourage them to think about how much they need to survive, and raise enough capital to do so. As we tell our CEOs, in all the years we have been at this, we have almost never met a CEO who regrets raising a little too much money.
Do they have a plan in place?
Finally, we work with our companies to come up with a contingency plan to ensure that they keep their customers in a down market. It’s all about surviving and thriving during change - so we ensure that our companies consider all options in these circumstances: should they lower prices, should they give products away free, should they slow down sales or changing marketing strategy - it’s all on the table.
When the tough times arrive, we work with them to intelligently lower their expenses: should they slowdown for a bit, should they look at debt, should they change international strategy. Small companies can change any of these elements quickly - that’s how they survive. And then, be ready for the recovery as the markets start growing again. As we’ve mentioned, if you examine the results of down markets, many survivors win big time by riding the wave!
For an interesting historic view of how startups should react, see the famous “RIP Good times” deck that Sequoia Capital sent to their portfolio companies when the market slid in 2008. Slide 40-56 are the most interesting.
Lessons learned: Our advice to tech investors
Think about how - if at all - the companies you invested in will be affected
But what about investors? Yes, there is market uncertainty and individual Brightspark investors need to think about the shifting circumstances: Europe/ Brexit; a volatile US president (to say the least), real estate red flags in Canada and the US; US debt; China and Russia - it makes us all pretty nervous and anxious.
But a slowdown does not necessarily adversely influence all tech companies. This is especially true in markets where customer spending will not significantly slow down as a result of a downturn (such as finding low cost travel deals, or trading-in cell phones). For example, in the event of a slowdown, we can assume that more than ever people will watch travel deals – which is where our portfolio company Hopper shines.
You can rely on your protective provisions
What about the valuation of existing investments? When there is a slowdown, private companies’ valuations don’t just dive - they aren’t at the mercy and irrationality of public markets and the associated volatility. The exception would be the need for financing a down round - in which case our pref shares have anti-dilution price protection. This means that as investors, we are protected so long as the companies we invested in just survive.
Making a downturn work to your benefit
So, what does an investor do in downtimes? Turn to cash, sell, procrastinate? Again historically, downtimes have been a good opportunity for investors to double down on winning private companies, and get into the best startups at a low price. Startups are all about disruption, and disruption thrives during uncertain times. In our experience, when things start improving, the survivors tend to well-outperform the market.
To wrap up
Volatility will probably happen when we least expect it and in a unique way. We remain convinced of the obvious: the tech revolution marches on, nimble startups with great leaders are prudent investments, and diversification makes sense. Meanwhile, the alternatives - cash, public markets, real estate – are pretty volatile and often unattractive investments.
We continue to prepare for the possibility of a downturn. If it doesn’t happen in the short term, no harm to our companies raising a little extra capital, or to our investors diversifying their portfolio. And if it does happen, we’ll be ready.
Remember the fundamentals
Brightspark invests based on solid fundamentals: have-to-have products, products that disrupt markets and create meaningful value, companies that are built to withstand market slowdowns and capitalize on opportunities, and most of all we invest in entrepreneurs that are resilient and can find opportunity in changing market conditions.
We tend to approach the market in uncertain times (and during downturns) just like we always do: 1) Diversify, diversify, diversify; 2) Have lots of patience 3) Do not panic; and 4) Double down on your winners. Obviously none of us can crystal ball the future, but we can point to how this strategy has been successful during previous market events.
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Aug 29, 2016