Month: October 2008

 In 2002 Warren Buffet sent this stark warning to his investors:

“In our view […] derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

Bill Gross was rumbling about the looming crisis in November last year.

Marc Andreessen predicted the “oncoming nuclear winter” on April 18th in Ning’s D round announcement when they raised $60 Million.

And here we are. Our biggest banks are failing. California (the worlds 5th largest economy) is running out of money. Two weeks ago our economy did almost collapse. Valley layoffs are starting. And every entrepreneur I know has that thousand yard stare.

All is not lost. If you, like me, run a technology startup, then you are in a better position than most to weather, and even profit, from the coming recession. Here’s why:

1. No more false economy!

For years there has been a false economy created by VC backed companies giving their services away for free to “go for growth”. The money gets consumed, the company goes away. But ten other promising startups in the same sector didn’t have the same runway and could not generate revenue to survive because the VC backed startup had forced everyone to give away the service for free.

As Wall St profits dry up and losses are incurred, many VC fund partners are unable to deliver the money they committed to their funds. So the amount of money sloshing around the Valley and other tech hotbeds will decrease.

With the venture capital glut removed we now have something closer to a free market among tech startups.  Bad ideas will be given less runway. Good ideas will get their just profits because pricing will be market driven by realistic supply and demand curves. At the end of the day the same number of startups may actually make more money.

2. Efficiency of execution will matter again

This false economy has caused an entire skill set to be ignored. There are many folks out there who are very good at running a high traffic website or a complex business with very little money, people and resources. In the false economy their skill has counted for diddlysquat. If you are one of these people, your time has come. If you’re competing in the same business side-by-side with an old school false economy entrepreneur who needs his team of 50 and and his 200 server cluster just to get off the ground, you’re going to eat them for breakfast and ask for seconds.

3. The relative risk of investing in a startup has decreased

The problem on Wall St and the global banking industry right now is one of trust. An economist will tell you that asymmetric information has led to adverse selection. That means that people lied so people got screwed and now no one trusts anyone lest they too get screwed.

If you’d like to know exactly how bad this problem is in real-time, check out the TED spread on Bloomberg. It tracks the inter-bank lending rate. It’s the closest way of tracking the credit crisis in real-time. Notice how the “bailout” has had zero effect on the bank lending rate. It did nothing to improve trust. In the week before the bailout the Fed injected roughly an additional $300 Billion into the global economy and that also had zero effect. Apparently you can’t buy trust.

Startups were just as risky before and after the credit crisis. Investors are still investing in a great idea and a great team and nothing more. In our world we don’t have credit rating agencies who have lied about bad CDO’s in order to drum up more business from other banks. Our credit worthiness started of as really bad and it’s still just as bad. And our potential return on investment is still just as enormous as it was.

While VC funds may have less money sloshing around from sources they’re accustomed to, this relative decrease in risk may attract new investors who now see us as far less risky since the alternatives are so much more risky.

4. It’s going to become easier to recruit great talent

Large companies are already shedding huge numbers of staff and many of them are talented people who were simply underutilized. With jobs being scarce and now that even large established companies aren’t a sure bet, it may also persuade risk averse folks who would not normally work for a startup that we’re not such a bad bet.

5. We don’t need credit anyway!

The commercial paper market is a huge credit marketplace that very stable, well capitalized companies with huge asset bases use to borrow money for short periods of time. They use the money to pay their staff and for their day to day operations. Unfortunately the commercial paper market has just about frozen. It’s become very difficult for even reliable companies to borrow the money they’re accustomed to have access to. Even the state of California is going to have to borrow from the government because they can’t raise money for their regular operations from the commercial paper market.

If you’ve ever tried to get a line of credit as a loss making startup with no history, you’ll know it’s near impossible. We didn’t survive on credit then and we don’t need credit now. And anything that causes the incumbents to struggle when we don’t have to is a competitive advantage for us.

6. Times of change create a greater need for innovators

As costs increase and spending decreases the incentives to find a way to do something better or cheaper become huge. If you can give Coca Cola a way to figure out that only 10,000 of their 30,000 people who have Microsoft Office licenses actually use the product, then you’re in the money. And if, because of inflation, the price of MS Office has gone up from $300 to $400 then  you’re saving them an extra $100 per user and you can charge more for your service.

7. A weaker dollar means you make more money

If the US economy truly is toast, that probably means the value of the dollar will fall. That means that every Pound, Yen and Euro your website earns either in direct payments or via ad clicks will be worth more. If 25% of your website traffic is from the USA, that means the net result is more money without you lifting a finger.

Now that you know how good you’ve really got it, and while everyone else is still crying down at the bar, go get caffeinated up and grab yourself a piece of this great opportunity!

~Mark