Fred Destin

The US is deep in recession (did I hear “depression”) mood.  The over-levered consumer is eyeing Chapter 11 and China is seeing exports slow.  The myth of decoupling has died an overdue death.  Yet somehow some in Europe seem to feel like the crisis is a distant storm.  Sure, it’s hurt their securities portfolio and a few local banks have been nationalised, but is it really going to affect their startup, and what should they do about it ?

Joe the Entrepreneur

Let’s think this through for a second.   Sector by sector; here is how Joe the US entrepreneur might be thinking right now:

• Mr Telecoms Semiconductor entrepreneur is somehow confident.  After all, the sector generates cash and is far from the leverage excesses of the Broadcom era.  Yet at Vodafone right now WiMax trials are discretely being put on hold as the divisional CFO’s focus on LTE / incremental spending / using whatever is already on the shelf.  Look for inventory levels at the big manufacturers as a leading indicator.  My assumption is that evolutionary technology from established groups will keep shifting, but that as a startup you better have some truly fundamental and badly needed silicon to sell.  Oh, and better sure you keep shifting that Bill of Materials down if you want to protect your margins.
• Mr Entreprise Software entrepreneur is rightfully panicked.  Apart from that 3-year SAP implementation, spending at his largest prospects has already been frozen and decision makers won’t return his calls.  From travel freeze to heacount reduction, innovation is not so high on the agenda at these big corporates anymore.  Better be sure you have a 6-month ROI or a cost-saving value proposition.  A SaaS model and recurring revenues will help !
• Mr E-commerce LinkArb Guy is an optimist by nature; his capital spend is more variable and he’s hoping the recession will actually accelerate the migration to online.  He’s battening down the hatches for the nuclear winter and hoping the mysterious folks at Google won’t switch him to SmartPricing and shoot his CPA.  But he believes that 2-years down the line, if he can make it, he will be coming out on top.  You know, like the last generation of burst bubble survivors.
• Mr Digital Media Dude is in media.  He’s loving it.  He’s seeing no drop in CPMs right now and his campaigns are holding.  Because he’s a bit new to all this, he’s probably not realising that CPM’s may hold but that next year’s campaign budget just got slashed and that his sell-through rate is about to go through the floor.  He’s betting on 10% growth instead of the 25% that was in his initial budget.  He’ll be just fine.  Maybe.

Joseph L’Entrepreneur 

My admittedly informal polls of naturally enthusiastic European entrepreneurial folks reveal a different picture.  It’s as if somehow it was not quite happening to them (and certainly is not their responsiblity).  “Well, the American consumer will have to learn how to save !  Now let’s talk about expanding into the US and take this opportunity to build market share.”

This reminds of a Zillow poll of US homeowners.  When polled about the likely fall in the property market, homeowners averaged something like 15% in the the next 12 months.  When polled about how much their own house would fall, the average was only 2%.  You just never think it’s going to happen to you.

You have read this before, but let’s just run through the basics of a credit contraction:

• Credit markets are shut.  The government is using all its bulletts to try and fix that.
• People need to pay their debt back the old fashioned way, not through refinancing but through free-cash flow.  And they have to do this in what may be a deflationary environment with weak or no topline growth.  That’s painful, and very slow. 
• Those who cannot, default.  As Martin Wolf put it in the FT, “deleveraging” is a euphemism for debt destruction.  Oh, and debt is senior to equity.
• So no pay rises, no new investments, no public money flowing into supporting consumption.
• So nothing dramatic at first, but a slow, painful, gradual cleanup and recovery.  The kind that grinds you down if you are not prepared for it.

Now with venture money, you have the benefit of a long-term investor (I almost wrote patient but caught myself in time).  Not a bad time to be building a foundation for the future.  But don’t get cocky or relaxed just because you got funding in the bank:

• The venture funding market may or may not be open for you for a long time.  The bar is going to be very high.  Fewer, larger deals will get done.  Running out of money in the next 12-24 months is just not a good idea, if you can avoid it.
• If the venture market does reopen, you may not like the terms or the price.  This is the era of 1X revenues as your pre-money and the return of the 2X-full-ratchet-cumulative-dividends-participating-preferred, folks.  Going to have to work hard to keep that share price up.

And now for the obvious and entirely predictable conclusion

Bottom-line is: what you have heard before is probably all true.  Don’t spend a euro today that you can spend tomorrow.  Assume the worst and then take another cut through your expenses.  Iterate.  Make capital efficiency a motto of everyone inside the company.  Banish the concept of middle management; if they are good, reassign them.  The litany is familiar, but fail to hear the call and you could be on the list of casualties.

Take a deep breath, make the cuts, readjust your mental exit date to two-years further out than you had planned.  You can always start spending later, and you’ll probably never regret saving cash today.

This time around, European entrepreneurs are reacting well to the assumption that the crisis will likely be deep and long.  We have all been through the last downcycle and know what to do, and that to do it early is best.

Our challenge, in all of this, is to keep our companies alive and healthy.  We are after all building disruptive winners. It just got harder, but it’s been done before and we can make it happen again.  Right now, I jus’t dont want to end like Wile E Coyote.  Gravity always catches up with you.