In an opaque market that has the world unsettled, Benchmark’s Bill Gurley has been doing his part to be more transparent. In early October, representing Benchmark, he authored a letter of advice to the founders Benchmark has backed, letting them know that while Benchmark remains supportive, it predicts a long and lumpy road.
Gurley, a top-ranked research analyst at Credit Suisse First Boston in the mid-1990s before joining Hummer Winblad in San Francisco and then Benchmark Capital in 1999, is also speaking more openly about his perspectives, and where Benchmark may head next. I caught up with him yesterday.
So, Bill, how long do you think this recession is going to last?
Probably years would be my best guess. I don’t have a crystal ball, but certainly public stock investors think so, or Microsoft wouldn’t be trading at 10 time earnings otherwise.
In your note to your entrepreneurs, you observed that in the last downturn, VCs were the “speculators; this time it is someone else. This means that the ‘crash on the beach’ wont be nearly as severe.” But the tech industry today is far more dependent on consumer products and services. As consumer spending crashes to a halt, what does that mean for Benchmark’s consumer-focused portfolio?
First, the last time around, you had startups getting revenue from other startups — telco equipment companies getting money from infrastructure startups. A lot of the people buying ads were selling ads. There were a lot of interlocking pieces, and a lot of codependence. I also think the portfolio balance at Benchmark has always been misunderstood. Consumer has never been more to 20 to 25 percent of our deals. Just think about MySQL [which sold to Sun Microsystems] or TellMe [which sold to Microsoft] or Good [Technologies, purchased by Motorola].
Are consumer companies more apt to be hit than enterprise companies? I don’t know that there’s safety in either. Consumers are certainly less immediately able to spend, but as soon as they pull back, other companies contract. Look at the auto industry or the financial services industry. So I don’t know that one sector is any better than another right now.
Your letter also addressed the inevitable impact that the crisis will have on other forms of capital available: angel financings, debt investments, presumably other venture capital firms that run out of money. How is Benchmark addressing this concern? Are you providing your companies with a little extra financing or anything else to protect them?
I’ve never heard of that particular approach. You wouldn’t know where to set the price point. The most obvious conversations that people are having is about cutting costs. Even an incumbent is going to cut spending on R&D right now, so you can afford to be smarter rather an more aggressive. If your ability to generate revenue and your ability to raise capital are compromised by the market, the only thing you really can do is extend your runway.
Not necessarily. I think you’d be surprised by delta of frugality that exists. There are some guys in our portfolio who are paying $3.50 a foot, then there are guys that are getting by in 75 cents a square foot down near San Jose. Some people make do with 150 square feet per full-time employee; others make do with 35 square feet. Those are the decisions and tradeoffs that people make.
Also, how much are you paying your [Standard] 409 auditor? Are you using a PR firm, and if so, could you take a more grass roots approach? Head count is just one variable that correlates with costs.
Speaking of audits, can startups really afford not to be audited from a liability standpoint? I’m sort of surprised by how many VCs seem to skip it.
I think an audit is a great thing that can be postponed for belt-tightening. Once a company starts to see revenue generation it becomes more critical. Certainly, we’ve decided to waive the audit requirement in most of the financing documents in a pre-revenue company.
And what is Benchmark doing internally in reaction to the crisis? What changes are you making?
First we want to try and help our companies, by giving them the information and tools they need. If there are alternative financing strategies, we’re helping them figure out what they are on a one-off basis for each particular circumstance.
Beyond that, we’re certainly cognizant of valuations having fallen, so we’re talking to public companies about whether they need funding. We haven’t done a PIPE in the past but we’re open to it. It’s like Warren Buffet has famously said: you want to be greedy when other people are fearful, and fearful when other people are greedy. People are very fearful right now.
Interesting. Are you talking to any of your old portfolio companies?
We did in the last cycle.
By the way, we also think it’s a great time to do Series A type stuff. One of the things that happens when you have peak and trough venture cycles is that peaks attract a lot of people who aren’t hard-core entrepreneurs; in troughs, you see tried-and-true entrepreneurs, and that’s where we are at this moment. Besides, if you’re funding a true Series A deal that’s two or three years from first revenue, you aren’t subject to what’s going on right now.
Is there any fatigue at Benchmark over companies with little in the way of clear and profitable revenue models?
What becomes more difficult in this environment is if you were doing a Series B or C of a telecom equipment company — that’d be tough because they’d need $300 million in funding to get to breakeven, so very highly capitalized deals will have the hardest time raising money.
Through these periods you have an almost seemingly overnight shift in investor sentiment from a glass is half full mentality to a glass is half empty one. When it shifts, then the deals where revenue model is a stretch, or the startup is targeting a seemingly small niche, starts having to answer much tougher questions. It’s an industrywide phenomenon and I do think it’s now become harder for anybody to raise money. You’d better have better answers to all those questions.
At the same time, if you haven’t figured out your revenue model but you have super viral traction, people will still fund it. It doesn’t mean that everything that goes that way will work out.
While we’re talking about shifting investor sentiment, what about institutional LPs? Their allocations to alternative investments are out of whack because of the public market meltdown. If they stop making commitments over the next few years — which some folks worry will happen — or they commit only to the “top tier” firms, what might that mean for the industry?
I think the potential exists in this scenario where you actually, for the first time in a long time, see a reduction in new commitments. LPs definitely want their asset allocation in the right place. Actually, their private [company commitments] just went down [in value], too, though the accounting mechanism isn’t in place to underscore that. So they’re more on track with their asset allocations than they realize. [Laughs.]
To the extent that you find it valuable for ideas that aren’t necessarily great to get funded, I guess it could be a bad thing, but I think some amount of shakeup is good. For the past 10 or 15 years, the venture industry has been overfunded.
And the IPO market? As a former analyst, do you buy into your former colleague Frank Quattrone’s argument that Eliot Spitzer era regulations are ruining everything?
I think great companies will always have the ability to go public. Staring down an S&P that’s down so much, you could argue whether going out tomorrow is a sensible thing to do. But yes, I do agree with that argument, totally. If you go back to 1993 and ask any top executive at a startup, “What do you want to achieve one day,” a ton would say, “I want to take a company public.” It was a badge of honor, like aspiring to compete in a professional sport. I think that aspiration is gone. People don’t talk about it anymore, and I think that’s a negative issue. Benchmark has 15 profitable companies with more than $50 million in revenue. If this were the mid ’90s, I suspect 14 of the 15 would now be public companies.
Whose share prices might subsequently tank. What about all the shareholders who lost money when startups went public more easily?
That’s true of most companies’ shareholders. Last time I checked, most major companies’ [shares] have been flat for the last 10 years, and that’s not really good, either.
What about your LPs? Are you doing anything to manage their expectations right now?
I literally look at it as, it’s our duty as executives and investors to increase shareholder value. The question is what is the right decision to make that happen. We have an interesting dynamic in Silicon Valley. There’s a lot of memory about ‘01 that wasn’t there in ’01. As a result, there’s way more cognizance than last time around.
What do you mean?
I’m interested to see how ’01 makes things play out differently this time. I think it could be a scenario where a competitor sees people laying people off, and instead of saying, “ah, they’re going out of business,” the thinking will be: they’ve already made staff reductions; they’re out ahead of me. There’s an openness to the idea that being pragmatic is smart; there wasn’t a lot of awareness about what that meant seven years ago.