Epistula #1: Wiser at Five
In a buyers market, a good time will not be had by all
Deciens marked its 5th anniversary in September. Surviving five years was far from assured at the beginning, and we’ve learned a few lessons. Periodically, we’ll share them and other thoughts on venture capital here.
Declining Towards Buyers
After an epic party, venture-backed companies, their investors, and founders are finally squinting at the house lights, trying to figure out what’s next.
The market downturn is starting to test the creativity and endurance of companies, while investors who bought into companies at rarified valuations are reeling from markdowns. In early-stage venture capital, the number of seed and angel deals has declined 36% this year. That’s tough for founders but encouraging for investors.
As the quick money disappears through the exit, it brings to mind one of the great party animals of all time: Warren Buffet. In Berkshire Hathaway’s 1986 Shareholder Letter, he dropped two now famous lines:
“We have no idea - and never have had - whether the market is going to go up, down, or sideways in the near- or intermediate term future.
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Let the after party begin.
Where Is the After Party?
Companies take many steps from formation to Series A - the “seed” stage. Each step has different characteristics. In the current environment of peak volatility, early-stage venture-backed companies offer good risk-adjusted entry points, if investors can understand the differences between the steps.
The earliest seed companies are still on the drawing board. Speaking as an investor, they are very attractive because you can buy the most equity per dollar going as early as possible. Similarly, the latest seed stage companies are an opportunity to enter more mature companies at great, risk-adjusted prices.
Companies in the middle are a different story. When capital was cheap, an investor could be confident that a company in the middle of the seed stage could graduate to a Series A. That is no longer the case. These companies are more expensive than formation-stage companies, but without much more data on critical metrics like product market fit (PMF). We’re happy to wait before getting involved.
PMF Blues
In this nervous market, predictions of disaster are easy to find. It’s a good time to consider why startups fail, so we can separate real warning signs from catastrophizing. We have seen our fair share of businesses struggle and have realized there are four major reasons investments go bad.
No PMF. Companies that cannot find product market fit are dead in the water.
Lost PMF. Some companies can’t or won’t adapt to a change in their macro market.
Weak go-to-market motion. A company can have PMF but not find a scalable, sustainable, economically viable go-to-market motion.
Team collapse. Teams sometimes fall apart along the journey.
Investors have to be smart and tactical to avoid these pitfalls. They need to keep evaluating product market fit and the executive team’s ability to keep it.
A lot of the anxiety about next year is channeled into Fed watching, but the US Fed’s focus on the 1970s can be misleading in one sense. While no one wants stagflation to return, the ‘70s were a vibrant time for technology-led innovation. Venture investors would do well to remember this. As Churchill said, “Never let a good crisis go to waste.” We can rest assured that venture capital is not coming to an end, even if the wider economy has a difficult 2023.
