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Recessions and (ir)Rational Confessions (2/2)

Part 2 of Customer Success in rough economic times. If you missed Part 1, find it here. This section was originally going to be tactical advice for CS teams. As the words hit the page, it morphed into an expansion on the economic logic of Part 1, with some predictions/ideas of how founders and investors can make lemonade out of the proverbial lemons. First, the TL;DR from part 1:

We're coming out of a bubble created primarily by technology investors. "Innovation" in corporate strategy has introduced systemic risk into the market in weird ways. Primarily, the market pricing mechanism is a bit wonky, and has spilled over into both private and public sectors. For tech companies, this will likely fall somewhere in-between the armageddon of early 2000's, and the inconvenience of 08-09.

Supporting Evidence

I'll let the quants and the forensic accountants do the proper deep dive, but I think it matters to expand on the claim that tech has introduced systemic risk. Like most bubbles, this one starts with improper risk assessment.

Over the past few years, companies seemed to move from seed to exit fluidly. I imagine some founders were pinching themselves, thinking "is this even real?".

In the last 10 years, market observers have seen a few valuations that made them think the world had gone a bit looney. I'd suggest this is largely due to the unregulated and speculative nature of early-stage investment, and misalignment on what defines "risk".

An individual firm might do some SWOT analysis, look at macro-economic trends, competition, emerging technologies, and potential regulatory or political risks. Investors will take this into account, but largely balance risk on the portfolio level, thinking in terms of IRR.

And, nothing eliminates risk faster than an exit. For investors, the name of the game is scaling quickly, and using funding events to either double down on their winners, or achieve liquidity with higher-risk investments. Because of the "scaling" part, its natural to seek continually higher multiples; as companies get larger, we can assume their competitive advantages are more valuable.

However, a bigger boat isn't necessarily less sinkable, nor more profitable. My feeling is risk isn't properly adjusted until firms hit the public market for a few years. To make this case, one only needs to look at Salesforce and MongoDB. Mongo has roughly the same revenue multiple as Salesforce, with roughly 1/10th the capitalization. We can say Salesforce is undervalued, but with just under a 5% margin, $120B is pretty generous. Forget the post-IPO firms for a moment, and think downstream to private firms who received a 6x-10x during their last valuation in the last few years. It's going to difficult to support those type of numbers during a recession. And, for shops with the majority of their capital tied up, liquidity may be an issue. This provides an immense opportunity for M&A.

Investors and founders need to be in open communication about their financials, and what can be expected for follow-on (or lack their of). Founders should also be speaking to competitors and complimentary firms who have backing by larger VCs or PE.

Larger shops should seeks deals which provide some strategic significance. And, these don't need to all be controlling share deals. Secondary-market transactions can provide skin-in-the-game to build ecosystems, and provide much-needed liquidity for investors who may have timed the market poorly.

These transactions also provide a much needed lifeline for founders, with new resources, potential funding sources, and even partnership opportunities which can offset increased growth costs.

Ultimately, the best case scenario will minimize failures, and quickly get a bevy of investors back into the marketplace. I'm as concerned by an ecosystem dominated by PE and massive VC, as I am one run by speculation.

Distressed firms should make themselves attractive to opportunistic investors. Focus on product, and source ideas from your small "c" customer success team. If you don't have the resources to build it, find it in the marketplace, and go make a deal. Get creative.

This is the fun part. This is why you got into it, eh?

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