The conventional wisdom these days is that we’re in a strange venture environment. Valuations have decreased drastically and funding activity has considerably slowed over the past 18 months. I’m frequently asked, “Why can’t startups raise capital like they did over the past few years? Is this the new normal?”
I’ve been around the startup and venture capital business for 24 years, and while I hate to be the bearer of bad news; this isn’t the new normal. It’s actually the same old normal, and I kinda like it.
Let me offer some insight.
The current situation reminds me of when I started my VC career in 1999, commonly referred to as the Internet Bubble. The Nasdaq more than doubled from January 1999 to Spring 2000. Then crashed in April 2000 and dropped by about 75% from April 2000 to Fall 2001. I see a lot of similarities between the Internet Bubble and the over-caffeinated funding environment we just witnessed from 2018-2022. Companies were able to raise big rounds quickly with little evidence of market traction, competitive differentiation, or ability to solve urgent customer problems. The prevailing theme was FOMO (fear of missing out). Investors paid extremely high valuations because they didn’t want to miss out on the next big exit or IPO.
So in 1999, one of my first experiences as a fledgling venture investor was when my firm invested in Akamai, an early content delivery network that provided the infrastructure to distribute media quickly and reliably. The company was growing quickly and had great timing. Or so it seemed. Akamai went public at $26 in October 1999, and the price shot up to more than $300 per share in less than three months. I couldn’t believe my luck. From everything I learned in my MBA, valuations were nonsensical, but it seemed like making money was going to be easier as a venture investor than I’d expected.
Then April 2000 happened. The Internet bubble burst. I quickly experienced my first “real” venture environment. Companies, which were turning away investors just months earlier, struggled to find capital. Thousands of startups disappeared. Many venture firms collapsed, and even the ones that survived struggled to raise new funds. Although times were suddenly tough for everyone, the early 2000s proved to be a formative period for me as a young investor. I learned several important lessons.
First, entrepreneurs need to have real passion. The reality is–even if it might seem otherwise during a frothy market–there’s no easy money. Oftentimes, before founders become founders, they’re in a job where they are seeing mistakes, faulty processes, and inefficiencies. So, they channel their frustrations to solve a problem that no one else is solving and know they can do it better than anyone else. The eradication of the problem and associated issues should become the founder’s sole focus, and singular mission. I call this equation Founder-Market Fit and it’s a critical characteristic for any company I back.
Passion + Expertise + Experience in a Target Market = Founder-Market Fit
Second, customers are going to try to solve their pain points themselves, so you have to sell products they truly need and can’t create on their own. This is normal, and the way it should be. As an investor in early-stage enterprise companies, I’m certainly no fan of longer procurement cycles which can delay startup market traction. Nevertheless, young companies need to be able to demonstrate maturity by showing that their products provide quantifiable value; they know how to identify and sell to target customers in a scalable and repeatable way; and their delivery model– implementation and support–ensures customer success. Unfortunately, too many startups have been ignoring these fundamental building blocks. My advice to founders is that it’s more important now than ever to find a wedge that you can sell to an enterprise.
Third, the company with the most capital doesn’t necessarily win. Startups, in recent years, were often able to raise large amounts of capital on story and vision at the expense of putting the right building blocks in place for a company to executive on sales, marketing, and other key functions. I feel bad for founders who did this without accurately measuring the ROI on how the money raised was spent. The best founding teams aren’t necessarily the best fundraisers, but they are the ones who know exactly when to press the gas and when to experiment without spending lots of capital, before trying to accelerate.
Finally, innovation doesn’t mean being the 116th company in a category. It always annoys me when too many companies get funding in a space, when there are so many new problems that need to be solved. It’s not good for the entrepreneurs or customers, nor is it good for technology integration. Take companies trying to streamline SOC II (Service Organization Control) compliance. Do we really need SOC II compliance companies that are doing essentially the same thing to fill 16 pages of Google search results?
Times may seem hard right now, but experienced investors and founders have seen it all before. We’re not in a new normal. It’s the same old normal that we’ve witnessed many times–2000 to 2005, 2008 to 2013– were two of my favorites. These times are when the most iconic companies are founded and built. Datadog, Cloudflare, Zoom, Slack, and Square are a few examples, but there are dozens of others.
I look forward to working with entrepreneurs who can take advantage of the current economic situation to create long-term, sustainable companies that will succeed in good times and bad.