Winter is coming to Tech/Startup Land. Are you an Entrepreneur or Investor? Hope you’re ready.

Yes, I’m ready to take on the world. Bring it!

Winter is coming. And not just in the imaginary land of Westeros. Winter is coming in reality…both literally (it’s getting colder already), and metaphorically (to the Startup/Tech world). But I’m obviously here to talk about the latter.

It’s incredible how Startups are changing the world. Amazing companies are being built every day, more and more people are leaving their careers and jumping at the opportunity to be Entrepreneurs (myself included), and our every day lives are being changed (often for the better) as a result. People seem happy. Companies are growing! Good work/life balance, feeling like you are changing the world, making (or hoping to make) lots of money…life seems good in Startup Land.

But I’m sorry to break the news, but this isn’t going to last…at least in current form. So get ready.

Lessons from an Equity Investor

I’ll again resort back to what I know best, equity investing, to highlight my case.

In the stock market, there are lots of opinions on why stocks will go up and down. Valuation, historical drivers, future earnings projections etc. etc. And they are all valid points. But in my experience, there are only a few GOLDEN truths in stock investing.

  1. The market goes up, when there are more Buyers than Sellers
  2. The market goes down, when there are more Sellers than Buyers
  3. The market tends to go up and down in multi-year cycles
  4. You want to Buy Low and Sell High

If everyone agrees, then the next step is think about how points #1~3 connect.

When there are more buyers, there is more money coming into the market, and thus drives stock prices up. When there are more sellers, there is more money leaving the market, and stock prices go down. And again, these up and down trends seems to hold true for multiple years. What am I getting at? It’s the next GOLDEN truth.

5. There are Liquidity Cycles (cycles of money coming in and out) that drive the market up and down

So now let’s connect points #4~5. Which brings me to my simple conclusion on investing…

A smart investor generally will want to buy stocks at the beginning of a liquidity cycle and not towards the end, as his chances to Buy Low and Sell High will be higher.

What do Liquidity Cycles have to do with Startup Land?

A lot actually. Just like the stock market, in the Startup world, money flows in and out and chances are there will be multi-year cycles of this. The reasons for when liquidity cycles start and end become a much more complicated discussion, but the important thing to know is that it happens. And as a company, it’s often easier to operate at the start of an up-cycle, and as an investor you generally want to invest at the start of an up-cycle.

Globally we have been in an upward liquidity cycle for multiple years now. Stock markets have been going up, housing prices have been going up, and tons of Startups have been getting funded. They are all linked in that money is flowing in to what are relatively looked at as higher risk assets (unlike cash or gold).

So what am I getting at?

I’m a believer that we are in the latter innings of this current upward liquidity cycle. Why? Part gut-feeling…and part because of my other personal thoughts on the macro-world, which is very similar to Henry Blodget’s view, which he illustrates a lot better than I ever could → if you’re interested, read it here:

But again if you want to simplify, what goes up, must come down…and we’ve been going up for quite a while.

What does a Downward Liquidity Cycle mean for Startups and Investors?

Well, it means there will be less money to fund Startups. This impacts those trying to raise money, and if your company relies on more money to grow, you are in for some trouble. It also means that customers will spend less (during down-cycles people play it safe, and wallets tend to shut), and that’s problematic as it means revenue at Startups will decrease. So again, less money in the system and troubling times for Startups.

It’ll also be troubling for investors as well. Many people may lose all their investments. They aren’t going to be happy (which is why I never liked the term ‘Angel Investor’…let’s see if they are angel-like if they lose their money). They will invest less in Startups. Less Startups will get off the ground. All around less money, and less people happy.

So WHY am I writing about this?

I’m not trying to play Dr. Gloom. Liquidity Cycles come and go and often make the system healthier in the long term.

But I wanted to write about this topic as I was amazed with all the euphoria that I often encountered since I jumped in to the Startup World. It’s as if this currently liquidity surplus will last forever. It’s as if you have a good idea and a good work ethic, funding will keep coming, and these other macro forces won’t matter in the long run…and frankly, I think that’s scary.

It worries me how many are focused on IDEAS and less on EXECUTION. It worries me that many are heavily focused on top-line USER GROWTH, while not spending enough time on RETENTION. Again, coming from equity investing, where we often emphasize cash flow and margins as a safety measures ahead of macro downturns when looking at companies, it just worries me.

So I’m not writing today to pour water on the fire. And for what it’s worth, I’ve come across many companies and investors that understand everything that I’ve talked about and are well positioned. But it still feels like a minority. Not enough people are talking about this. So I’m writing this post today in hopes that more people in Startup Land talk about liquidity cycles, what it means, and how to prepare for it.

That’s enough for today…until next time.