Trust disappears in all sorts of ways. Sometimes it’s quick, like when you come home unexpectedly and it turns out you probably shouldn’t have. Other times it erodes gradually over time, like ocean tides lapping at a sandstone cliff until one day, out of nowhere, it yields to the sea.
Investing is built on trust. Trust in founders and executives. Trust in business models, pro formas and projections. Trust that the future is bright.
Without that trust, even that which has existed for years can evaporate overnight. And no matter how many times history repeats itself, it always seems to surprise so many. There were always reasons why this time, really — no, really — it was different.
But it’s never different. The waves always win.
Investors are asking a lot of questions about technology companies right now. Their trust has been shaken by slowing growth, shrinking margins, fraud, global headwinds and shaky valuations.
In the coming months, questions are likely to increase in intensity. Can you really grow that fast? Can you grow that fast without raising more money? If you can’t raise more money, how quickly can you become profitable? Will employees still line up to drink the Kool-Aid after you lay off 20% of your staff? And the ultimate question: when will be the bubble burst?
But that’s the wrong question. What we really should be asking is how long ago it popped.
The day LinkedIn announced disappointing earnings and the stock lost half its value, one analyst lamented that the day’s action reminder her of 2000. That Friday, virtually any company that even smelled like Silicon Valley got smacked around — bad news or not.
The analyst went on to describe how a publicly traded software analytics company delivered relatively upbeat earnings and a vote of confidence from the CFO. Wall Street responded with a more than 20% haircut. Her conclusion, displaying a remarkable inability to grasp the historic context she herself called out, was that the market had lost its mind.
To borrow from the lexicon de jour: Really?
Wasn’t the year 2000 when the NASDAQ peaked, the world realized that delivering large, heavy bags of dog food wasn’t a viable business model and the dotcom bubble burst in spectacular fashion? When, as it were, markets finally came to their senses?
On the way up, a founder can walk into a room and slap down a hockey stick chart from the lower left to the upper right and swear up and down that his app or marketplace or whatever is going to be the next big thing and investors believe it. They trust that he knows his business, and that the dozens of other investors putting money in alongside them know what they’re doing.
Due diligence? Whatever. Ask investors in Zenefits about due diligence. FOMO is as real on Sand Hill Road as it is in The Mission, and “growth at any cost” is turning out to too expensive to believe in.
And that’s how you get a hundred and something private companies worth over a billion dollars, and why the argument “yeah, but it’s different this time because these companies are making money” held water for so long. “Making money” isn’t the same as being profitable, and even if revenue did count as making money, the top line dries up like that when your only customers are other venture funded companies that can’t get funding now, either.
Animal Spirits soar on the way up. But they’re a bitch on the way down.
In 2006, everyone “knew” that home prices only went up. And that property values in Oregon were uncorrelated to those in Florida. Or Vegas. Or Phoenix. Or Dubai. We all believed, and the market ran. Banks lent. Borrowers borrowed. And we all got rich, on paper.
Then when those two universal truths got shattered, that home prices sometimes do go down and that geographically disperse markets can become correlated when lending standards everywhere loosen to the point of insanity, the fancy models on Wall Street went haywire. All hell broke loose.
And it all started when we lost faith in what we had previously known to be true. Prices were “too high,” for years, but it didn’t matter because the market believed the lie. Until it didn’t. Then, and only then, did the web of toxic acronyms (MBS, CDO, CDS, etc) unravel.
Real estate here in San Francisco has been flashing signs of waning trust for months now.
I had drinks with a friend of mine last year who told me his big San Francisco developer buddies were shelving plans for new projects. The reason? Out of control construction costs, material shortages and political headwinds made new projects economically unviable. This in a city with skyrocketing rents, record high property values and a housing shortage that had been dubbed a “crisis” for going on three years.
Up until that point, I had been flooded with stories of bidding wars, crazy prices and lavish tech company perks. But these were simply the kind of anecdotes you told years after the bubble burst as signs of the peak. Tops are a process (bottoms are an event), and those stories can go on for years without a correction.
But here was a distinct shift. Market participants were changing their behavior, scaling back on risk, for the first time in this cycle.
This month, for the first time since the market recovered, we will rent an apartment for less than it rented for a year ago. That’s one reason I love this business: we see the bubble bursting in real time, on the ground, while the rest of the world can’t tear its eyes away from headlines about stock prices.
What that poor misguided analyst pointed out that fateful Friday is exactly what I’ve been seeing: Investors no longer trust what technology companies are selling. Especially those relying on ever larger rounds of funding to pay two dollars for one dollar of revenue. Or worse.
Investors don’t trust founders, forecasts, CFOs or hockey stick charts. And it isn’t simply that founders have to drive down to Sand Hill Road again and hit the circuit to re-convince venture capitalists that they’re still committed to making the world a better place.
Investors in those huge late-stage rounds of the past two years now hail from all over the world. Including New York. And New York is reeling. With bank and money manager stocks getting hammered in recent weeks, don’t count on the big mutual funds — who are notorious for being the Greater Fool — to be all that excited about a Series G round for another app that delivers pre-made meals or dynamically prices your (probably illegal) AirBnB listing when regulators are asking why they didn’t write down their investment in Zenefits more than they already did.
So if you’re a technology company with a business model that relies on new funding rounds to make payroll, there are really are only two options: abandon ship, or start bailing, because the public markets are all but closed to tech, with no significant IPOs having happened in 2016 and none on the calendar in the near future.
Hack headcount. Fire the kitchen staff. Cancel free massage Thursday. Sell the custom-built kegerator(s). In other words, try to actually make money (profit).
Predicting when investors will lose their trust is a fool’s errand. But what is significantly more foolish, and a sure way to lose lots of money in dramatic fashion, is to hear the record skip and ignore it, burying your head in the sand like so many other ostriches too focused on how smart they are, how well their investments are doing — on paper — and why problems thousands of miles away don’t really matter.
It’s remarkable to me how often I hear people who I consider otherwise reasonably intelligent say that this downturn will be a blip. Are they paying attention? Or do they simply hope it’s a blip?
I am reminded that the consensus is usually wrong, and right now the consensus in San Francisco is that sure, some companies will fail which is probably a good thing, but it won’t be that bad. There’s no real basis for this view — it’s rooted in hopes and dreams and a trust that no longer exists.
I am long-term bullish on this city. Very bullish in fact, otherwise I wouldn’t do what I do. But a comeuppance is overdue. Downturns cleanse the bad ideas and bad actors from the system and provide fertile ground from which strong, enduring companies and ideas can emerge. It’s a process. A painful one, but it’s necessary and inevitable.
Ostriches don’t actually stick their heads in the sand to avoid predators. That would be stupid: It wouldn’t work (plus, they’d die of asphyxiation). It turns out, what they’re really doing is sticking their heads into their nests to move their eggs around.
Booms like this don’t end well. Bubbles don’t fizzle, they burst. And this time isn’t different.