BUSINESS BLOGS
BUSINESS BLOGS
category: business
21 Nov 2008

Some time ago, I published a post that linked to an article on ReadWriteWeb that talked about bootstrapping a firm, which made me think of legendary Sequoia VC Mike Moritz’ investment thesis, or Elements of Sustainable Companies, which calls for frugality, amongst other things, which include:

Clarity of Purpose

Summarize the company’s business on the back of a business card.

Large Markets

Address existing markets poised for rapid growth or change. A market on the path to a $1B potential allows for error and time for real margins to develop.

Rich Customers

Target customers who will move fast and pay a premium for a unique offering.

Focus

Customers will only buy a simple product with a singular value proposition.

Pain Killers

Pick the one thing that is of burning importance to the customer then delight them with a compelling solution.

Think Differently

Constantly challenge conventional wisdom. Take the contrarian route. Create novel solutions. Outwit the competition.

Team DNA

A company’s DNA is set in the first 90 days. All team members are the smartest or most clever in their domain. “A” level founders attract an “A” level team.

Agility

Stealth and speed will usually help beat-out large companies.

Frugality

Focus spending on what’s critical. Spend only on the priorities and maximize profitability.

Inferno

Start with only a little money. It forces discipline and focus. A huge market with customers yearning for a product developed by great engineers requires very little firepower.

I think one reason why Mr. Moritz’ firm themselves called for their portfolio companies and start-ups in general to cut costs by 10% is two-fold:

- the economy’s wheels have come off, with talks now of deflation becoming rampant.

- VCs have investments that are certainly underwater.  Think about it: if private investments were benchmarked to publicly traded firms like Google and the Nasdaq index, then considering that these are now down 50% year-to-date, obviously their investments are too.

The problem is a security that is liquid (ie. a stock) can reprice immediately.  A private investment, not so.

Right now, VCs are hit with the perfect storm that includes their investors (so-called limited partners) balking on their own commitments to invest.  Some pension funds are outright trying to unload their stakes in VCs for $0.50 on the dollar, let alone adding more money.

If you add all of these variables into the mix, it becomes a lethal combination.

Faced with this reality: VCs will certainly ask companies to cut costs, and may even ask for their investments back, in order to focus on companies that have a shot at attaining liquidity.  Considering that many of these investments were “pie in the sky” experimental ideas with no business case to support their existence, I think you will see a massive wave of foreclosures of businesses and liquidations.

As of mid-September, I began to get emails (we’re talking 1-2 per week, nothing more, but still) from worried executives or investors asking me if we wanted to “take over” a firm or “buy on the cheap” a company.  These emails have only increased in frequency and the sense of panic.  Why?

Because their burn rates are too high and with no revenue in sight, the only thing a responsible investor can do is pull the plug.  Right now, the value of a company has everything to do with revenues, costs and profits.  This is a great thing.

As I pointed out previously in the above-mentioned post:

The value of a stock, company, asset etc., simplified, is = Future Earnings / Cost of Capital.

As such, to maximize the value of your company, it’s not enough to only keep costs down or to have a high-quality asset, you have to do both. This is basically Gordon’s Model theory applied to video publishing.

Mark my words: as the severity of the credit crisis has somewhat dissipated, what will happen is that companies with cash will start to scoop up companies right and left who simply want to stop their own bleeding.  After all, in a deflationary environment, asset prices fall.  If your burn rate is low or you are profitable, you don’t have to sell.  In fact, if you operate online, this is the perfect time to continue to execute and grow the firm.  But if you are suffering from a high burn rate, don’t be surprised if you find the rug pulled from beneath you any day now.