Sequoia Capital has become one of the most closely watched market prognosticators of the modern era, so when a 52-slide presentation from the venture capital company began leaking online earlier this week, entrepreneurs and investors listened closely.
The company, whose “R.I.P. Good Times” memo in 2008 and “Black Swan” missive in March 2020 proved to foretell coming economic crises, lays out a collection of risks that founders could face in the months ahead, calling the current environment a “crucible moment.”
“First and foremost, we must recognize the changing environment and shift our mindset to respond with intention rather than regret,” the presentation says.
While the document notes “this is not a time to panic,” it does warn of uncertainty and change ahead—and offers advice on both how to get through it and hints at what founders can expect while the economy rights itself.
Here are some of the biggest takeaways:
This isn’t a redux of the early days of the pandemic
While the U.S. economy tanked in March 2020, it rebounded quickly, an action economists call a V-shaped recovery. Sequoia says that’s not going to happen this time around.
“Many of [the monetary and fiscal policy] tools have been exhausted,” the presentation reads. “And sustained inflation, and geopolitical conflicts further limit the ability for a quick-fix policy solution. . . . We expect the market downturn to impact consumer behavior, labor markets, supply chains, and more. It will be a longer recovery and while we can’t predict how long, we can advise you on ways to prepare and get through to the other side.”
The presentation notes that it’s hard to peg a specific time horizon on how long the recovery will take, but it won’t be quick.
Sequoia’s not alone in that prediction. Last week, Lightspeed said in a blog post, “The boom times of the last decade are unambiguously over.”
Preserve cash and beware the “death spiral”
The presentation urged founders to “confront reality” and be prepared to make changes. While not every business needs to slash spending and hiring immediately (as some already have), they should have the pieces lined up to do so quickly if that time comes.
“Do the cut exercise (projects, R&D, marketing, other expenses),” it reads. “It doesn’t mean you have to pull the trigger, but that you are ready to do it in the next 30 days if needed. . . . When you have just six months of cash left, focus becomes incredible. Get that focus now, regardless of how much you have in the bank.”
Companies that move quickly, it says, will have the most runway if economic conditions worsen, which will help them avoid a “death spiral.”
The VC gravy train is shutting down
Fundraising for startups has never been easy, but monetary policies during the pandemic made venture firms more willing to invest. Just as Sequoia is warning entrepreneurs to guard their money, it indicated it would be doing the same, which could point to rougher waters for founders looking for funding.
“The cost of capital has fundamentally increased,” the presentation reads. “Over the past two years, monetary policy loosened to avert an economic disaster in the midst of the pandemic. Negative real interest rates led to effortless fundraising for growth companies and record valuation levels. Given the circumstances, that was perfectly rational. But now rates are rising, money is no longer free, and that has massive implications for valuations and fundraising.”
The market is in tough shape. Nothing you can do about that.
VCs are taking a lot of meetings and not writing many checks. Nothing you can do about that.
The only things you can control are 1) Your growth rate 2) Your burn rate and 3) your messaging.
Focus on those.
Common stock even more at risk from recaps and down rounds so there is alignment between founders, employees, and investors. The cost of capital has changed materially, and if you think things are like they were, then you are headed off a cliff like Thelma and Louise. pic.twitter.com/Vqw5SGq4Sd
— Bill Gurley (@bgurley) May 23, 2022
The IPO market in the coming months could look a lot different
While the presentation didn’t specifically address the future IPO market, it did note that recent IPOs have been among the worst performing assets. Nasdaq’s current performance, it says, is the third largest downdraw in the last 20 years (though it’s not quite as bad as 2001 or 2008 yet). And 61% of all software, internet, and fintech companies are currently trading below prepandemic levels, despite many doubling both their revenue and profitability.
“The market is clearly indicating that the valuation framework over the last two years is no longer relevant with the removal of free money,” Sequoia says.
The presentation also touched on changes in valuation, noting the financial markets are a barometer on the economy.
“The valuation swings we all see are a reflection of uncertainty about demand, changing labor market conditions, supply chain uncertainties, and war,” it says. “These are all factors that will ultimately affect your businesses.”
The days of growth at all costs are over, Sequoia notes. Instead, investors today are looking for companies with profitability. And in the medium- to long-term picture, consistent growth will lead to improved margins, which investors will reward.
There is one bright side
While the presentation is a gloomy one on the whole, it does point out one area of optimism. Because FANG companies are instituting hiring freezes, the talent pool is about to become deeper and recruiting should be easier for those companies that are in a position to grow, even in a limited fashion.
“Look at this as a time of incredible opportunity,” Sequoia says. “You play your cards right, and you will come out as a strong entity.”