how startups should handle a downturn

How Startups should handle a downturn

Yogesh Pathak

Startup Times of india

Rediff

SIFY (Satyam Infoway)

On the other hand…Amazon P/E : 290

Bubbles• If several companies, public or private, can practically never realize

the high valuations they once had, and trade at 10% to 40% of their peak valuations, we were certainly in a bubble• By definition, we realize this post facto

“Only when the tide goes out do you discover who's been swimming naked”

- Warren Buffett

Why bubble happen• Overhype of a given sunrise sector, technology,

change in consumer habits, etc• Throwing more capital on ideas and companies than

they deserve / absorb• Public markets throwing their usual evaluation

benchmarks in the wind • Herd mentality• Grow big fast• Investor and entrepreneur hubris• Expectations of exponential growth• Overhype of disruptive ability

How to spot a bubble• Surge in entrepreneurial activity• Surge in funding activity• Ludicrous-sounding business models

(Try the “Grandpa Test”)• Benchmarks other than P&L are

invented and deemed-super important• Growth is priority #1, not profitability;

High burn rates• Valuations increase at a rapid rate• Funding increases at a rapid rate• Negative unit economics

• Subsectors of interest keep coming up, and all are seen as rosy

• Employees sucked by start-ups and investors from other sectors

• High salaries • Crazy employee perks• Unheard-of deals, at unheard-of

valuations in unheard-of geographies• Investors, media and start-ups drink

their own kool-aid• Commoners take risky investment bets

(e.g. taxi drivers buying stocks, IT managers becoming angels)

Unicorns!

Bubble Capital = Excesses• Box Inc (listed)• Revenue: $ 300 m• Valuation: $ 1.5 b• P/S of 5

• Dropbox (private)• Revenue: $ 400 m• Valuation: $ 10 b• Funds raised: $ 1.1 b• P/S of 25• Perks: $25,000 per employee

Chrome Panda $100,000

Irrational Valuations, 1999eToys• Valuation: $ 4.9 B• Revenue: $ 100 M• Op. Loss: $ 123 M• P/S = 49

And many more…

Toys R Us• Valuation $ 3.9 B• Revenue $ 11 B• Op. Profit $ 400 M• P/S < 1• 1500 stores in 38 countries

Irrational Valuations, 2015Airbnb• Valuation: $24 B• 2015 Revenue: $900 M - $ 1 B• 2015 Op. Loss: $ 150 M• P/S = 24

Marriott • 4000 hotels• Revenue $14.5 B, Op. Profit 9% • Valuation $ 17 B • P/S < 1

Expedia• Revenue $ 6.6 B, Op. Profit 13%• Valuation $ 16.5 B• P/S = 2.5

Downturn• Performance in underlying valuations is not reached• Capital raising difficult even when capital is available• Sense prevails and irrational deals peter out• Valuations revised downwards• Downrounds start happening, often at harsh investment terms• Prominent companies shut down with all investor capital lost• Public and private market meltdown together or in phases• Extremely difficult for new startups to raise funds• Customers cut spend on IT• VCs funds go into a shell and some shut shop

Questions to ask in a downturn• Is my business idea/model, based on a bubble-era assumption of customer

uptake or market growth?• If so, revisit the whole thing!

• Business idea/model is sound but growth expectations unrealistic?• Can I raise capital in a downturn?• Can I run without raising capital? How long is our runway?• Can there be a plan A (with capital) and plan B (without capital)• What is our business and are we going to have fun building it?• How can we become more resilient?• What is our secret sauce for customer loyalty, moat, and competitive advantage?

Things to remember in a downturn• Keep the dream alive• Stick to the basics: Customer Value, Revenues, Profits• Do not overextend on expenses• Have a 9-12 month runway with current cash and burn• When capital is available, TAKE IT. Avoid haggling on valuation.• If need to shut down, do it gracefully. Honour all commitments. Pay all liabilities. • Explore M&A as an alternative to shut-down. Keep the dream alive.• Help fellow entrepreneurs• Watch the market. Prepare for the next upturn.• Watch the competition.• Spend more time with customers and fine-tune your offering.