Staying in the Game

A colleague recently told me about a well-known public technology company that is widely admired for its business efficiency and durable growth. It is a stock that you may or may not own yourself if you’re the kind of person who reads this newsletter.

He remarked that although the company is today renowned for its rare “Rule of 40” style combination of growth and profitability, things were not always so rosy. The company was — at various times — not so fast growing, and/or frequently high-burning, and had a series of early stage executives and investors that cycled out because they thought the company’s best days were behind it. Even some near-death bankruptcy scares. Today it’s one of the top 10 highest-valued SaaS multiple companies, but at certain points in its trajectory it looked like a bit of a clunker, the kind of company you could easily pass on as a Series B or C or D investor.

This story made me think about what exactly we’re doing here in the venture capital business.

When VCs invest in an early stage business, they’re investing at prices that are pretty far divorced from reality when it comes to intrinsic business value or fundamentals. Marc Andreessen calls this “buying a portfolio of long-dated, deeply-out-of-the-money call options”. Prices at 100x revenues became the norm during the go-go times of 2020 and 2021, but even the 10x revenues that has been a common benchmark during my venture career sounds pretty ridiculous to my micro-PE friends who buy entire companies for 3x or 4x EBITDA.

Venture capital is sort of a belief in the miracle of compounding. Ten or twenty times revenues is a pretty insane price to pay for a money-losing asset when you can buy the S&P 500 for twenty times earnings… unless that asset is growing very fast, and there is a path to profitability at scale, and you can hold onto that asset for a long time, say a decade or more. 

That final point about holding period is actually very important. My same micro-PE friends like to tease me about how not only are VC bets expensive but they are illiquid, which makes them twice as bad. I counter that illiquidity is a feature, not a bug. Charlie Munger once said that “The first rule of compounding is to never interrupt it unnecessarily.” If you’re investing in a category where the entire point is for the companies’ compounded growth to outpace the degree to which you overpaid on the way in, it only works if you’re allowed to hold on until it does just that.

The illiquid, locked-in arrangement between founder and VC actually allows for pretty darned good alignment, once product-market fit has been found and growth is happening organically. You might argue about the particulars — how much to burn, whether this certain executive is doing a good job or not, whether to raise new money and how much — but big-picture, both sides are aligned on removing all roadblocks (such as: running out of money) that could interrupt compounding growth from doing its thing. The goal — assuming things are generally “working” — is to ride this puppy out for as long as possible.

It’s noteworthy that in an environment where so much good comes from playing the long game, 99.9% of the information and advice that we’re inundated with daily has to do with short-term decisions. CNBC is supposed to be about investing yet the entirety of the content is about what is going to happen in markets next week, which is not investing but rather speculation. And everybody in the tech ecosystem is worried about what 2023 will bring for valuations and fundraising.

That’s not unimportant if your cash runway ends in April, I’m not saying it is. But what I wish more people were asking was “what kind of moves can I make right now that will look really smart in 2030?” Both on the investing and the company-building side.

Somebody once said that startups are acts of persistence — if you can just stay alive long enough, enough of your competitors will have died or given up that you’ll own the market by default. That might not be exactly right but it’s not exactly wrong either. There’s something to be said for doing what you can to survive and live another day, particularly in pretty brutal tech winter that might be as bad as anything we’ve seen since the Global Financial Crisis.

So here’s to the survivors. The cockroaches. The burn-cutters, the pivoters, the hiring-freezers, the “slow down now to speed up later”-ers, the runway-extenders, the flat-rounders and the down-rounders. Here’s to everyone making hard decisions to stay in the game for another trip around the sun. There has never been a great success story that did not involve dark & scary chapters along the way.

Happy 2023.