April 17, 2020
This week, we’re having tea with serial entrepreneur and investor, Elad Gil.
In a past life, Elad started the Mobile team at Google and co-founded Color Genomics. Now, he’s an investor and advisor to companies including Airbnb, Pinterest, and Stripe. He’s also the author of the High Growth Handbook.
In this episode, Elad shares:
How both early and late stage companies can adjust to a downturn
The amount of runway you should aim for
How to position decelerated growth to investors
Why now is a great time to start a new company
This interview has been lightly edited for length and clarity.
Elad Gil: I think we’re definitely going to go into a longer and deeper recession than some people seem to expect. Fundamentally, I think about it as a 2x2 matrix where on one side you have, “Are you being helped, hurt, or neutral by the coronavirus?” Certain online collaboration tools are doing better and actually accelerating as shutdowns happen. In contrast, there are certain businesses that are being decimated right now, travel related companies as an example. On the other axis is, “Will this shift sustain or not?”
It’s possible that some online learning companies have all the kindergartners on right now, but two years from now when everything’s back to normal, they’ll go back to a much lower baseline.
It depends if you are early or late. If you’re four people, you have low burn already. If you’ve just raised a seed round, I would quickly make sure that you can continue to grow in this environment and that what you’re building is still relevant. Unless you’re in something like online travel, where you’re not going to have a business for the next year. You’ll never be able to prove out metrics that allow you to keep going, in which case you may just want to consider doing something different.
It depends on what you consider late. Even at 100 people, you’ll probably have a $20 million a year burn which is significant, so I would start asking the question of how to make your cash stretch. That may mean raising prices on customers or getting paid in advance. It could mean having to freeze hiring or having to do layoffs. It may mean having to redeploy your team against customers that you know are a good customer segment, and cutting the more speculative things that you were doing. It’s really asking, “How do I have sufficient cash to be able to bridge this and then have another six months to a year to recover?” So if you do need to raise more money and are not profitable, you can show a growth story to be able to do so.
If you’re seeing strong growth and you can scale it in an ROI positive manner, it’s totally worth continuing to scale it. The main thing I would keep track of is the marketing and sales expense that you can gear back if you need to, and headcount expense.
The mistake people sometimes make is ramping headcount because they think a big business is there. And then the business suddenly goes away because of shifts in behavior, but now they have a broader built-in burn rate. It depends on where expenses come from.
It depends on where the baseline gets reset to. If you end up getting reset to 2X from where you are today, that’s great. It may have saved you a year of struggling for customers and growth because customers are now looking for you. Zoom has probably been accelerated by two or three years in terms of enterprise adoption, so even if usage drops because people actually start meeting in person again, it’s going to start at a higher baseline because more companies will have adopted it.
They should be looking at both revenue and cost. It’s going to sound really obvious, but how do you increase revenue? How do you have customers prepay? How do you make sure they have cash coming in the door? On the cost side, what is the real cost structure that you need and how should you sustain that?
If you need to do a layoff, the big mistake people make is they don’t cut deep enough. Or they wait a long time and end up with dramatically less runway, so you’ve both done a layoff at that point and still don’t have enough money to keep going. If you do decide to do a layoff, I would do it early and I would do it much deeper than anybody expects.
Try to end up with at least two to three years of cash. It may take a year, or more, for this to bottom and then start to come back. Then you need to show a quarter or two of growth before you can raise more money, and you need at least six months to raise. That puts you at a minimum of two years; if you can get three years that’s better. That may or may not be realistic.
The other option is to consider exiting. The best time to exit may be in about six months when bigger companies have done their layoffs and/or hiring freezes. And if you’re doing very well but don’t think what you’re doing is sustainable after things snap back, now may be the time to exit if you don’t think it’s going to last.
Are people spending time on your offering simply because they don’t have any other choice?
I have two young kids at home. We’re trying different learning platforms but once they’re back in school, we’re not going to be using these things every day. I would try and be self-honest around what is forced behavior versus a real systemic shift.
I think the biggest version of that is working from home. As a parent of young kids, my productivity is taking a real hit. People without kids are being extremely productive at home, but part of that is because they have nothing else to do. They can’t go out, they’re quarantined. So I think the takeaway a lot of people will have is that working from home works great and everybody should be a distributed team. But my experience is that about 10% of people are extremely effective working remotely, 90% are really bad at it, but today they’re really good at it because they have nothing else they can do.
It’s a mix of motivation, tools, and I think there are certain roles where you have to interact with people frequently in person in order to get certain things done.
I think it helps but I don’t think it’s the panacea. There’s a reason people were still getting on flights and doing sales calls. Maybe they’ll do fewer of those after this, but I don’t think it’s going to be zero. I think it’s 20% fewer.
I’ve been seeing a number of things close. In general, it’s companies that were either in-process and just made it over the finish line, or it’s companies that are accelerating through this period.
Questions to ask yourself as a company are:
Financing events are still happening. That said, a lot of VCs are sitting on their money because they think that things are going to get worse over the next six months. For the companies that are clearly blown up by this, they need to cut cash or be willing to take money on bad terms to make it through for when things come back.
If it makes sense for them to do so, absolutely. In general when these market downturns happen, things always feel very cheap to the founders. They always worry, “Oh, it’s a 20% discount from where I thought it would be.” And then the next month it’s, “Oh, it’s a 40% discount,” and the next month, it’s “Oh, it’s a 60%.”
My suggestion would be get it done fast if you’re going to do something. Don’t over-optimize; take a deal that you think is bad now. Because in 60 days, it’s going to look like a great deal because the market is sliding. If you set your price and the market slides faster than you can close the thing, you’re going to be stuck. You won’t be able to raise money.
I mean, the reality is Facebook did a giant down round.
Yeah, everybody forgets all the history on this stuff. In 2008, Facebook raised at a $15 billion valuation from Microsoft and then they had to raise at somewhere between $8b and $10b. That’s when Yuri Milner came in and did the combination of secondary and primary. So Facebook, one of the most important companies in the world, had a down round. It’s perfectly fine to do one if your valuation got way ahead of your business and you were betting on always being able to raise more money.
You may be in a situation where you’re now burning through a lot of cash and potentially rightfully so if it’s helping build a business and the business is still working. It’s just going to be harder to raise money. And if valuations and multiples have come down, you may need to be willing to accept the fact that valuations are lower now. Even if you have a great future ahead of yourself, you need the capital to accelerate your business and make it stable. If you raise enough money to never have to raise again, you’re in great shape.
It depends on your business and how well you’re doing. Say you went from 20 to 50 million in ARR. Your original plan for the next year was 100, and now you think you’ll do 70. You just say, “Look, here’s how we’ve been impacted. This is how our projections have shifted. Based on this plus the environment, we want to get something done quickly. Here’s how much we want to raise, let’s talk through valuation.”
It should be a very rational conversation. I know a number of people in the venture community who are actually looking for opportunities like that because these are fundamentally great businesses that are going to need capital. The real question is, at what price? As mentioned, price is going to continue to slide until we hit some bottom on this.
It’s better to take the pain and raise at a lower valuation than you think now than to wait another six months, and then raise at another 30% discount because all the prices have come down.
There’s absolutely a lot of money on the sidelines and there are a bunch of people who have just closed funds. The flip of it is, the venture community was burning through capital at a faster pace than they used to. The fund cycles used to be every three years or so. More recently, VCs have been raising every 18 months.
If you raised a billion dollar fund 12 months ago, you’re probably two-thirds through it. Some of these funds are going to start shrinking fund sizes because they won’t be able to close the money. Again, that’s probably 6 to 12 months away assuming that this is an ongoing economic issue.
I’d view it through the lens of, “Is this going to be additive to my business long term?” Because the reality is, one way or the other, in 18 to 24 months, we’re going to be largely through with this.
If it’s purely philanthropic, great. You don’t have to justify it. If you’re really trying to build a business around it, you need to ask yourself if you have something sustainable here as a business or not.
Fundamentally, now is a good time to start a company.
There is going to be a lot of talent available in the market; you’ll be able to hire and build teams; there’s still a ton of seed capital around. You may not get the same valuation but you’ll still be perfectly fine. And early stage companies just don’t consume that much cash.
There’s tons and tons of stuff to build. There are really interesting vertical SaaS opportunities, there are remote work opportunities, there are industry-specific opportunities because every industry is now working remotely for the first time.
The one other thing to consider too is now may be a great time to build social products. There are a lot of people at home with no other outlet, so you may be able to get very fast social adoption of products in a way that you couldn’t before.
Want to hear more? Subscribe to Series Tea on YouTube, iTunes, Spotify, Stitcher, or your favorite podcast app.
You can also send us a note at [email protected] We’d love to hear what you thought of the episode, or who you’d like us to have tea with next.
The Mercury Team