For the better part of the last decade, Silicon Valley tech companies have seemingly been on a mission to make up for the down years following the burst of the dot-com bubble, spending money at a record clip. The new offices have been stunning, the sales kickoffs have been larger than life, and the holiday parties have been nothing short of extravagant. Unfortunately for a majority of those companies, who have over-indulged in the exuberance, this joy ride is coming to a screeching halt.
Apple, which is often the poster child for the S&P 500 and widely considered the “consumer’s stock,” hit a YTD low of $92.11 earlier this month, which has set the tone for the rest of the tech market. Twitter, GoPro, Fitbit, and many more companies that were once considered darlings of the unicorn club, have suffered serious hits to their stock price to start this year and have been trading below their initial IPO price. To make matters worse, crude oil hit its lowest price point since May 2003, and there have been commodity busts worldwide.
Understandably, this has created a palpable fear all across Wall Street. There is only one way for companies to gain investor confidence: show the ability to produce yield. This is true for public companies that have been pummeled over the last few weeks as well as the private companies that have been looking for a quick exit. The most reassuring thing a company can do for its investors is to turn a profit and put money back into their pockets. It will be especially important during these bear market times, as the VCs want nothing more than liquidity so they have the flexibility to shop for their next investment.
Chasing yield has lead to underperformance
With commodities underperforming and tech producing home runs like Google and Facebook, investors have been willing to take their chances in the private markets. Unfortunately, this has yielded far more risk than reward. Some organizations have been more interested in adding users to create impressive top-line growth for their business than focusing on sales to build a profitable business with a healthy bottom-line. This has resulted in freemium business models, mega rounds of funding, and extremely crowded markets.
On the investment side, it has opened up the floodgates for venture capital funding. VCs have poured money into the startup ecosystem, deploying more than $58.8 billion in funding during 2015. “Free money” is flowing, and some companies have jumped at the opportunity, often to their detriment. For example, Jawbone, which has taken over $1 billion in investments over its lifespan and saw its valuation hit upwards of $3 billion, was just forced to take a down round of $165 million at a $1.5 billion valuation. While investors’ eyes were big, the expectations were just too lofty.
Capital is drying up
While many entrepreneurs initially made the IPO their “holy grail,” many of them have been steering clear of the public markets. This inclination to remain private longer means VC money will inevitably dry up. With fewer companies going public, VCs will see less return on their investments and so will have less money to play with. Although investors may be frustrated, they are begrudgingly aware of the motivation behind the initial bets they placed. At the same time, startups have become increasingly wary of the source of their funds. Mattermark CO, Danielle Morrill, said it best when speaking to Farhad Manjoo of the New York Times: “If you can get $200 million from private sources, then yeah, I don’t want my company under the scrutiny of the unwashed masses who don’t understand my business.”
Aside from cheap cash in the private sector, there is an understandable fear of the public sector. CEOs watched companies set low price points for their IPO all year in 2015, banking on an opening day pop that would create investor confidence for the following months. What’s very clear is that the public markets are not willing to support companies with a top heavy S-1 – especially in this most recent market downturn.
Back to the basics
Those of us who’ve been in the Valley long enough to have experienced the dotcom boom of the late ’90s, can attest to the frenzy created around shiny Internet startups. That was a rapid rise that led to an even more dramatic fall — bringing business models under scrutiny, driving inflated stock prices down, and increasing demand for cash over flash.
While I don’t believe this is Bubble 2.0, tech has been long overdue for a major correction, and it is time for entrepreneurs to pay the piper — in other words, pay back their investors.
As a CEO it may be difficult to keep all stakeholders in an organization happy, but it is important to stick to the fundamentals and stay true to the core values of business – cash flow, profits, and sustainability. As VCs tidy up their portfolios in 2016, you can rest assured that a path to profitability will be number one on their agenda for all of their investments.