Let It Rain

Bill Bing
Bill Bing
Feb 20, 2016 · 5 min read

I joined Upromise as a Customer Service Representative back in 2002, when venture-backed startups were sort of a bad joke that everybody was sick of. Despite a gloomy market, Upromise had done well to fill its coffers before the crash, raising capital from top VCs like Charles River Ventures and General Catalyst.

That funding enabled the company to weather the storm over the next 4 years as it switched CEOs and created a new Upromise Investments arm, in search of a business model and value proposition that resonated and provided value to customers and partners. Once the market started to turn in 2006, Upromise was acquired by Sallie Mae for $308 million.

In 2007 I joined Square 1 Bank, where I helped manage a portfolio of early stage companies in Seattle, Utah, San Diego and Colorado. Square 1’s business model relies deeply on relationships with venture firms and their stated support for companies that otherwise would not be able to secure debt due to their limited liquidity and cash burn.

In 2008 I was given the opportunity to co-found the firm’s first VC Fund-of-Funds — Square 1 Ventures. As Principal and VP I was intimately involved with fundraising and investment activities, and when Lehman Brothers filed for bankruptcy in September it was a shot across our bow. We spent the next 6 months desperately scampering to close the fund while the institutional investment world was falling apart all around us. Despite the madness, our novice fund ended up being the top performing PE fund of its vintage year.

Oh, and while Square 1 Bank was undeniably putting out fires and herding cats for a couple of years after the financial crisis, the company IPO’d in 2014 and was acquired by PacWest a little over a year later for $849M.

Great. What’s the point right? A couple of companies I worked at got lucky in spite of bad macro events?

Quite the contrary. I actually believe that the companies succeeded in no small part because of the market environment. You see, while it is common conception that a bad market favors investors and is bad for startups, I believe the opposite is true.

Mark Suster did an excellent job of explaining why VCs don’t want a down market. The TLDR version is basically that other than first-time fund managers, VCs have existing portfolio companies that may go out of business or at least materially lose value during these stretches. Another big reason that he doesn’t mention is that a down market makes fundraising excruciatingly challenging for all but the very top firms. And most of those firms are smart enough to not have to raise during these times. When the perception is that startups are overpriced people don’t want to invest in them, and when people don’t want to invest in them, institutional investment dollars into the venture asset class dry up.

One positive scenario is for those investors who raise money immediately prior to the market scaling back. This becomes a huge competitive advantage over other investors with capital constraints. All of a sudden you’ve got the same supply of companies with half or even a quarter of the demand. In short, it’s a buyer’s market. For proof look no further than our fund at Square 1 Ventures; we invested in a bunch of VC funds that had closed just prior to the market collapsing. The reason we did well is because they did well, and part of the reason they did so well is that the odds were stacked in their favor.

Enough about investors. Let’s talk about startups. For the last couple of years the investment climate has been frothy, with abysmal interest rates prompting non-traditional investors to seek yield elsewhere. The result has been an explosion of angel investment and new entrants into the VC and later stage (<cough> “pre-IPO” <cough>) market. A number of companies have been piling up cash and channeling it towards growth with a “we’ll figure that out later” approach to profitability.

Not all companies though. Some companies have been getting that creeping feeling, sort of like the guy from the Great Outdoors who has been struck by lightning 66 times… IN THE HEAD!

As Danielle Morrill noted, they’ve slowed their burn rate and started raising capital; not because they have to, but because they know what they can do with it in a down market.

When the market changes companies with high burn rates get screwed. Management teams get replaced, overhead gets cut by 20+%, benefits are slashed, and the mercenaries and tourists decide to go home. Companies with a compelling mission and strong governance can survive. Those same companies with a bunch of cash in the back can dominate.

In an up market, everyone can focus on growth with minimal regard for managing the business. It’s like a downhill bike race — everyone clusters together and it’s hard to gain separation. Once the tables turn however, the winners emerge and gain separation. While some companies will become sidetracked by re-orgs, layoffs and changes in strategy, the companies that have managed cash burn and corporate purpose all along, and that have ample capital in reserve can keep growing (intelligently) and can even accelerate.

They can do this because market opportunities will present themselves that only they will be prepared to take advantage of. Competitors will disappear or become cheap acquisition targets. Talent will come knocking on their doors, seeking refuge from imploding, mismanaged companies. And investors and potential acquirers will take note and start to develop strategic relationships with these companies.

This isn’t a theory — I’ve lived it multiple times. So while investors are rooting for a perpetual up market, the best startups and entrepreneurs are rooting for a down market. It weeds out the weak players propped up by pools of cash, perks and unwarranted hype. It forces everyone to play by the same rules and prioritize profitability as well as growth. And it enables separation and domination by the companies who are focused on solving important problems under responsible management strategies.

Let it rain.

Bill Bing

Written by

Bill Bing

Startups/strategic finance focus. 4 exits for > $1B (Upromise, Square 1, DAS Communications, TransLoc).