Sequoia warns start-ups: It is not the strongest, most intelligent that survive

You may have seen Sequoia Capital’s recent presentation to start-up founders, titled “Adapting to Endure”.  I first saw it here. It’s more than 50 slides, so here’s my summary in under 1000 words – for those, like me, who lose focus after 10 slides. In case you’re not familiar with Sequoia: they are one of the first, and biggest VC funds in the world – having invested in Apple, Google, Instagram, Airbnb, and Stripe. They have raised more than $15B in capital. It’s also led by a fellow South African, Roelof Botha, which, of course, is worth mentioning.

Similar to Y Combinator’s message to their portfolio companies a week ago, here are the key takeaways from Sequoia’s presentation:

Why we are here

Mr Botha reflects on his days as PayPal CFO, and highlights similarities between the 2000’s dot-com crash and the current market downturn. They survived, innovated, and re-focussed by cutting costs and monetizing their product.  

The presentation emphasizes that rates are rising, money is no longer free, and that has massive implications for valuations and fundraising. The valuation swings we’re seeing in the financial markets are a reflection of uncertainty about demand, changing labor market conditions, supply chain uncertainties, and war.

There is a quick mention of Sequoia’s widely-published Black Swan memo, how they got the monetary and fiscal responses to the Covid pandemic wrong, and that currently, sustained inflation and geopolitical conflicts limit the ability for a quick-fix solution and V-shaped recovery.

The result of monetary stimulus and the Ukrainian war

The presentation looks at the massive monetary stimulus governments put in place in response to the pandemic, with the Fed’s balance sheet holding almost 3x more treasury securities as a result. The liquidity creation led to a demand-spike resulting in bottlenecks and distortions throughout the real economy, leading to supply chain challenges and price pressures.

The war in Ukraine exacerbated the supply chain complexities and resulted in a commodity price squeeze, worsening inflation outlooks which can be seen by the 5-year forward inflation expectations being at the highest levels in decades.

The Fed has two jobs, maximise employment and manage inflation. The latter is now of utmost importance, expect abrupt rate hikes and a decrease to its balance sheet in order to contract liquidity.

Capital was free. Now it’s expensive. We're in the early innings of the initial shock flowing through to the real economy, backward-looking fundamentals can paint a particularly unreliable picture of what’s to come. What’s certain is that the economy is set to slow, the debate is about the magnitude.

Public markets

It’s not quite 2001 or 2008, but the Nasdaq is down 28% since last November. 61% of all software, internet and fintech companies are trading below pre-pandemic prices, losing more than 2 years of stock appreciation - despite many of them doubling both revenue and profitability.

Growth at all costs is no longer being rewarded. EV/Revenue multiples across software have been cut in half over the last 6 months and now trade at 5.45x, 6% below the 10yr-average of 5.8x. More significantly, growth adjusted multiples are trading 34% below the 10yr-average.

It’s not all about growth anymore

Investors favor near-term certainty to potential growth and focus is shifting to companies with profitability and positive cash flows which translates into meaningful value appreciation.

Don’t expect "cheap" hedge fund capital to save the day, they are attending to their public market wounds and hybrid funds are trying to re-balance their portfolios which are now at over-capacity w.r.t private investments.

What history tells us

The only way to stop inflation is to stop purchasing, less money to buy = shrinks economy. The timeline for recovery is predicted to... not be quick.

Who wins?

"It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.”But, adaptability alone is not enough for survival it seems, you also need to be the quickest to respond and cut costs, within the next 30 days actually.  

The CEO’s who face reality, adapt fast and have discipline rather than regret. Recruiting will get easier, but you need to ensure you can get through the next 6 months, at least.  

Preparing

  Yourself:

• Confront reality. Don’t be the blind optimist that dies of a broken heart as described by Jim Collins
• Confront fear. Don’t let it cloud your problem-solving ability
• Recognise the opportunity at hand and seize the moment
• Your personal assignment should be managing change

  Your team:

• Start with why & reaffirm your mission/values 
• Showcase your leadership, 2 D’s and 4 C’s: give Direction, be Decisive; Communication with Conviction with Confidence with Calmness
• Be authentic, be human, balance optimism and realism
• Align your team & ask for commitment

  Your company:

• Track your cash runway daily
• Create financial degrees of freedom: earn more customers, improve unit economics, cut excess, raise equity or debt if you can (survival > terms you don’t like)
• When recognizing constraints, focus turns to finding a better solution rather than throwing money at the problem

Follow Airbnb’s response to the pandemic

• 30% YoY growth in March 2020 to 80% of bookings cancelled in April
• Principles: be decisive, preserve cash, act with all stakeholders in mind, emerge as role models, play to win next season, don’t trade in the future
• Do 4 things: raise money, manage stakeholders, diversify the business, cut costs

My favorite quotes:

• Chance only favors the prepared mind
• This is not a time to panic. It is a time to pause and reassess. Respond with intention rather than regret.
• Wishful thinking is a waste of time
• “If the world outside your company is changing faster than the world inside your company, the ends is near” Jack Welch

What’s next:

The most ambitious, most determined of you will use this moment to rise to the occasion and build something truly remarkable. That was true for Cisco after the crash in 1987, Google and PayPal in 2000 after the dot-com bust, Airbnb in 2008 in midst of the financial crisis, and DoorDash in 2020 during the health pandemic.