By Bernard Lunn
There will be another recession/bear market. Nobody knows when or how deep, but the statistical probability of mean reversion is a horse worth betting on.
I am guessing that the current wild market (correction in a bull market telling you to buy the dips? start of a bear market? Hedge Funds playing chicken with the Fed?) has made more entrepreneurs take notice of macro cycles.
I am not trying to write a depressing post. I think software is eating the world and there has never been a better time to launch a startup, particularly in Fintech. Many really great ventures got their traction in a downturn (eg Lending Club in 2009, Google in 2001).
From a macro viewpoint, 2015 feels like 1998. In both times, technology was the driver and oil prices were low (which is good for everybody who does not own oil related assets) and in both times the crisis shock was from Asia.
It does not feel like 2007 when all the signs were screaming recession in America. The economic recovery in America and UK maybe too slow and unequal, but it is a recovery of sorts and there are emerging markets with promising data points such as India.
Here is the comparison between now and 1998:
|Interest Rates||Rising||Forecast to rise|
|Time to crash||Two years||????|
|Market Turmoil||Thailand, Korea||China|
The coming crash of the faux unicorns driven by media hype
Yes, there is a bubble. It is not in the public markets where valuations maybe a bit stretched but nowhere near crazy levels. In Public markets for example, Apple has a PE of 12, HP is 11, Cisco is 15. Sure there are many over valued tech stocks and guess what happens – short traders spot that and bet on the stock falling. That market discipline does not exist in private markets and that is why there is a bubble in private markets where in comparison with 1998:
- Seed is the new Series A
- Series A is the new Growth Equity
- Series B is the new IPO
The bubble is in private deals for hot tech stocks, for the simple reason that you cannot short private stock.
For now it looks like “every ones a winner babe“, but when the tide goes out we will see who has been swimming naked. The biggest losers will be founders who chased the unicorn headlines. In order to get that Unicorn headline, some entrepreneurs gave away some details in the term sheet around Preference rights that look like a niggling detail in good times and a “what on earth were we thinking?” horror in bad times.
I still think that unicorns are cute (so,we kept that pic on @dailyfintech)…but they are rare. That is the point. The current unicorn mania is like Veruca Salt in Willy Wonka – “I want a unicorn and I want it now”. Building a billion $ worth of real value in a few years is very hard and very rare. Not everybody can have one.
In December 2014. I published my list of Fintech Unicorns. It is a short list, because my criteria is realizable value for common stock over $1 billion. That means:
- Either: Exit with over $1 billion in cash to shareholders (equity in highly liquid stock with no selling restrictions counts).
- Or: IPO with over $1 billion in market cap.
This is nothing new.
Most startups fail and a very, very small number become very, very big. All the Unicorns together are not worth as much as Apple.
We do not know what is happening behind closed doors of the current masters of the universe on Sand Hill Road. However when you see this kind of bubble, it must end in tears. Most of us won’t care. The hurt will be limited to a few people who have the financial strength to handle it. This is not like 2007 when millions of people were impacted.
The mirage of the Bitcoin mulligan
One sign of the bubble in private tech funding is the mirage of the Bitcoin mulligan.
In golf a mulligan (aka “do over”) is a second chance to perform an action, usually after the first chance went wrong through bad luck or a blunder.
If you worked through the 1990s Internet gold rush and you did not call every shot perfectly (who did?), the narrative that Bitcoin is like the Internet in the early 1990s is hugely appealing. It is like having a time machine. You know how it will play out, so you can make that perfectly timed prescient bet.
This is a mirage. Back to the Future is only a movie. Time travel is impossible. You cannot see the future. The future always surprises.
That mirage can be dangerous if you act on it. VCs with a lot of money are tempted to make huge bets because “if all you have is a hammer, everything looks like a nail”. If you have lots of money under management, it looks like you can grow markets by throwing money at them. Two deals stand out as representing this kind of hubris:
- 21 Inc with $121m put into a venture that few can explain. That is a seed round. Yes, over $100m into a seed round sounds like a bubble to me.
- Blockstream with $21m (that number smacks of insider joke hubris) for open source that has yet to be accepted by developers in a market that is still nascent and may fail.
The birth of the Anti Fragile Fintech Unicorns that will benefit from a market downturn
Lets turn to the good news.
One of my favorite business books is Nassem Taleb’s Antifragile (which has more insights per page than in the whole book by most writers). A Unicorn is Antifragile. It benefits from massive change. LendingClub (and other Fintech Unicorns) benefit from the credit implosion of 2008 occurring at the same time as the explosion of digitization.
Almost all other businesses are harmed by massive change. Normal businesses that do well are like cart horses. They are tough and resilient, so they can withstand the brutal knocks of massive change.
However cart horses don’t benefit from massive change, they survive massive change. Only Unicorns benefit from massive change because they are Antifragile.
Today we are in a period of greater than normal change with three tsunamis hitting at the same time – digitization, deleveraging and globalization – creating lots of Black Swan events. In this environment, Unicorns can be lower risk than “normal” businesses.
Cart horses are good businesses, but Unicorns are awesome.
How do you get massive traction in a downturn?
In short, how can you be like Lending Club in 2009 or Google in 2001?
In simple terms, you have to ask:
“Does my value proposition work in a deep recession/bear market?”
In even simpler terms:
“Can you offer 90% of the value for 10% of the cost”?
90% is enough to get people to switch if it is 10x cheaper.
If you have some seriously disruptive technology (e.g. trustless blockchain systems) you could be very popular in a recession offering:
- Lower cost sharing economy services. Uber, AirBnB and other sharing services can get away with a big % take today. What if somebody charged 1.5% rather than 15%? What if that 1.5% included payment processing by cutting out credit cards? We will then stop referring to “sharing economy” which sounds all lovely and social and refer to what it really is which is squeezing cash out of unused assets.
- Taking a big axe to core enterprise systems. Big companies love to cut deep during recession/bear markets. That means taking a disruptive approach to the big “keep the lights on processes” that account for 80% or more of the costs. These are the kind of Blockchain use cases that Richard Gendal Brown of IBM analyses so brilliantly.
- Services for micro multinationals. In a global economy, there are millions of entrepreneurs in the developing world that want to sell globally. In a recession in the West, many will join them as forced entrepreneurs. Make it cheap and easy for them to do business and your platform will scale in tough times.
Google sold a lot of advertising, but did not use advertising to scale its business. Ditto for Facebook. If you have a really strong proposition, then organic word of mouth will do the marketing for you and you don’t need a mega round of capital for marketing costs.
At time of posting, Mr. Market has not yet decided if this is a correction in a bull market or the start of a bear market. If the 1998 comparison is accurate, this is a correction in a bull market that is reminiscent of the Asian Financial Crisis in 1998. (I was working with a Korean banking software company at the time and it did not look like a blip if you were at the epicenter).
Nobody knows when this bull market will end but we do know that a) it will end sometime and b) that tech will power the recovery as it is now so embedded in all our lives. When it does end, the faux unicorns will crash and a new breed of unicorns will be born (while talking heads are proclaiming the end of tech startups).
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