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For the past several months there has been a growing chorus of alarms about the impending slow down in the startup world. While a number of pundits are still in denial and the reverberations haven’t reached Europe or other trailing regions, it is undeniable. Winter is here.
Unicorns are stumbling and are being written down by their late stage investors. Average valuations for rounds in Q4 2015 were down 60% from the previous quarter. (Soon we’ll find out how Q1 2016 fared.) Over 70% of tech companies that went public in 2014 are trading below their IPO price.
More importantly, in the dark and smoky (not really) board rooms on Sand Hill Road, men in wrinkle-free chinos, light blue shirts, and boat shoes are scheming. They are the ones who actually write checks. They saw this coming and began digging in for the winter ahead months ago.
No one knows how long it is going to be, but investors are now looking towards fattening up their portfolio companies and only investing in sure things. Sure things, in Silicon Valley investor vernacular, are companies with profitable unit economics and/or teams who have a track record of making money for VCs.
Well, if you are on the investment side, you are probably celebrating the return of sanity and good deals. After all, numerous legendary tech companies were started in the times of Silicon Valley famines. The pendulum is swinging hard back in to the favor of professional investors. Hobbyist angels who bid up the early stage valuations (and founder egos) are running scared back to the safe havens of real estate and shorting the market. Silicon Valley steroid-infused unicorns are shedding talent, increasing supply and lowering the insane salary market. All of this will mean a healthy deflation from the excesses the past 7 years of Silicon Valley’s bull market.
If you are a first time founder without a track record and no product with traction looking for seed money, I’m afraid I have bad news for you. Your options are narrowing to bootstrapping your project to some level of success like the good ‘ol days and/or carefully picking the right accelerator program that can help you get to an investable state faster.
If you are fortunate to enter this trough part of the cycle with a product, solid team, and some traction; you may be in better shape. For most business models, nothing matters more right now, than unit economics. Much like the life and death requirement for a pilot flying through stormy weather relying on instruments alone; this means fully understanding the instrumentation of your business. If you are a disciplined entrepreneur this should always be the first and last thing you think about no matter the funding or macro economic environment.
First, your Customer Acquisition Cost (CAC). What are your marketing channels, do you know how to fully leverage them, and do you know the various saturation points to surmount?
Second, your gross and net margins. Are you one of the 42 VC-backed food delivery startups in San Francisco subsidizing everyone’s lunch hoping to starve out your competition before you run out of money? Or do you make at least gross profit on every customer on the first order?
Third, your customer Life Time Value (LTV). For many competitive business categories, especially ecommerce or SaaS, the CAC is too high to come back on the first order. That means keeping your customers happy long enough to produce a net profit over some months and for them to invite their friends… who are a net zero CAC to you.
No matter what side you are on, know this: the party is most definitely wrapping up. It is 3 am, the music is quieter, some people have already taken their gift bags and gone home. The hosts are tired and want to go to bed. So be smart and disciplined. Don’t get distracted with things that feel like work. Like picking out furniture, marketing spend that doesn’t bring measurable results, or hiring every person you meet. Focus on one metric: LTV > CAC. And relentlessly execute.
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