Sequoia Capital has warned on tough times ahead for the tech sector. Last week the US venture capital firm gave a presentation on Zoom to 250 of its entrepreneurs and details have leaked to "The Information" website with the clear messages and immediate measures that it felt its portfolio companies should be taking. Suggestions included a demand to cut expenditure, to reassess the budget over the next month, and to focus on profit rather than rapid growth.
Sequoia Capital is one of the largest and longest-established venture capital firms with extensive investments in Israeli startups including unicorns like Wiz, Gong, Fireblocks, and Starkware and over the years it has also invested in tech giants like Google, Apple and Airbnb.
Sequoia has also built a reputation over the years as an unofficial barometer for by publishing reports ahead of economic crises in the tech sector with forecasts and tips for entrepreneurs to cope with the anticipated storm. In 2008 at the start of the sub-prime crisis, Sequoia gave a presentation entitled "R.I.P. Good Times," while at the start of the Covid pandemic it sent out a memo headlined "Coronavirus: The Black Swan of 2020." The reports aim to help the heads of Sequoia’s portfolio companies cope with difficult realities without cutting corners and denying reality.
Sequoia’s latest report urges entrepreneurs, "to adapt themselves in order to strengthen their position."
The forecast: Slow and long recovery
In contrast to the Covid situation, Sequoia does not see a swift exit from the latest crisis. On the contrary, the venture capital firm told entrepreneurs that the recovery from the crisis would be slow and long, among other things because the government incentives and monetary policy that injected cheap capital into the tech industry have been exhausted by the Covid crisis.
"Recovery will take time," the presentation said, "and it is difficult to see when it will end but it won’t be fast. The Covid pandemic forced governments to inject grants into industry; the war in Ukraine has raised fuel prices; global supply chain problems have also led to inflation - and now it seems that the only way to stop it is simply to stop buying, but that will essentially lead to an economic downturn."
Market expectations for interest rate hikes began to circulate last September as the stock markets began to fall. The rate hikes by the US Federal Reserve have serious consequences for the market: over the past six months new US mortgages have become 67% more expensive - the biggest such hike in more than 50 years.
The rise in US interest rates will make it difficult for startups and tech companies to take loans. From now, the cost of capital so that a startup can protect its valuation will be much higher.
The plan: Don’t be scared of cuts
Cuts have always been a painful process for entrepreneurs. Even if they do not include layoffs, they can result in the cancellation of development plans for new products and entering new markets, or simply delaying hiring more employees that could support the company’s growth. Sequoia does not seek to console entrepreneurs and suggests that they be prepared to make swift cuts in expenditure. "Don’t view cuts as a negative but rather a means to conserve cash and run faster."
Sequoia said it is not calling for immediate cuts but rather the preparation of backup plans so that when the time comes their finger is already on the trigger and they can put the plan into action.
Sequoia proposes that entrepreneurs examine spending on special projects, development, marketing and other expenses and prepare a plan for cuts that can be implemented within 30 days. "In the 2008 crisis, companies that made cuts were clearly more efficient and better."
In order to encourage entrepreneurs to adopt a realistic approach and not to deny reality, Sequoia recounts the story of US Navi Vice Admiral James Stockdale, the most senior American officer to survive captivity and repeated torture during the Vietnam war. Stockdale said that it was the optimistic who thought that they would be released by next Christmas, Easter or Thanksgiving that did not survive. When this did not happen again and again, they died of a broken heart. Stockdale told his fellow captives that they would not be out soon and to get used to the idea. This has become known as the Stockdale paradox.
Recommendations: High revenue from every user
Based on the experiences that have survived previous crises like online footwear company Zappos and Airbnb, Sequoia recommends that startups generate higher revenue in the short term from all users. "That’s the best thing that entrepreneurs can do during this period. In previous crises, Zappos increased the range of shoes that it sold and consequently encouraged buyers to place bigger orders."
Sequoia’s second in priority recommendation is to focus on revenue for higher profitability as the expense of expanding and acquiring a greater market share. Airbnb, for example, achieved this by cutting marketing budgets. Zappos achieved this by cutting customer payment plans, requiring buyers to pay a higher proportion of the price of the shoes in their first payment. A third recommendation by Sequoia is to cut staffing levels and the final recommendation is to take loans.
The opportunity: Shortage leads to creativity
A lack of financing can lead to companies finding creative solutions. Zappos, for example, made use of capital from customers to implement special plans like gift cards, building financing plans for stores that they worked with and extending repayments to stores from 30 to 90 days. Although the company cut marketing, it actually invested in customer service and technology to encourage customers to order more items in each order.
When the FANG tech giants (Facebook, Amazon, Netflix and Google) freeze new employee hiring, hiring for startups becomes easier. Whoever copes with the reality, adjusts themselves to the situation and adheres to discipline, without any regrets, will triumph. Try to view this period as an opportunity for you: if you want to overtake a long line of cars, it is easier to do it on rainy days than sunny days."
Sequoia’s grim forecasts are dramatic presentations that resound throughout the tech industry. But the venture capital firm did come in for harsh criticism after its misleading forecast at the start of the Covid pandemic in 2020, when tech companies were boosted rather than hit hard. Although Sequoia did then couch its gloomy predictions by saying that it would take several more quarters to know if we could gain control of the virus and a lot more time to discover if the world economy was recovering.
On this latest crisis, Sequoia admits that it does not understand the way in which fiscal and monetary policy (government incentives during the Covid crisis) are distorting the whole picture. But this time those tools have been exhausted while galloping inflation combined with geopolitical conflicts are very much restricting the ability of governments to provide quick solutions.
Published by Globes, Israel business news - en.globes.co.il - on May 26, 2022.
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