History doesn’t repeat itself, but it certainly rhymes—or so the saying goes. For entrepreneurs, I believe 2021 and the years to come will rhyme with 2007.
In 2007, I worked in leveraged finance at a top Wall Street investment bank. When I started my job, it was so busy that I could barely find a place to sit on the trading floor. Within one month, the institutional debt market locked up and nearly every deal we were working on collapsed.
In 2021, much like 2007, we’re experiencing historically low interest rates and global liquidity—as a result of massive quantitative easing and stimulus. Similar to 2007, this stimulus has arrived around the time of a new election cycle, causing policymakers to make short-term decisions that are politically expedient.
You can see the impact of low yields all over the place, including public market hedge funds launching growth and early-stage venture funds without previous experience, new financing vehicles like SPACs, historically high cryptocurrency prices, venture funds of unprecedented size, and a high volume of venture funds that raised new capital before 2020 who are still early in their fund cycles.
Momentum versus Fundamentals
When there’s more momentum-driven capital chasing fewer fundamental-driven opportunities, this story always ends the same way: at some point, whether now or in a few years, there will be a ‘flight to quality’ and entrepreneurs will experience the opposite side of the pendulum.
Entrepreneurs should plan for this now. You can do this by choosing to work with great, fundamentals-driven, and all-weather venture investors. These are the partners you want by your side and on your board when the tides eventually shift.
Advice for Entrepreneurs
Here’s my advice about what specific actions you can take as an early-stage entrepreneur to identify that you’re working with an all-weather, fundamentals-driven investor:
Tip #1. Ask About Bridge Rounds and Pivots
Ask your prospective investors about specific examples when they’ve helped bridge rounds for companies that have significantly missed their growth targets or underwent a major pivot. Then, talk to the CEO who was at the helm of the company during that pivot. Regardless of whether they stayed in the role, what was his or her experience?
#2. Back Channel
Make sure to back channel to previous CEOs who are no longer around. Look up their track records—including failed companies—and reach out directly. Do your own due diligence, just like they’d do when they offer up a term sheet.
#3. Validate Real-World Turnarounds
Do they treat entrepreneurs with respect during challenging times? Have they bridged companies when no other insiders were open to it? Do they or their firm have examples of successful turnarounds? Are they able to respectfully disagree and maintain strong, long-term relationships with founders?
#4. Learn About Their Board Leadership Approach
How are they as board members? You’d like to work with people who speak their mind, even if non-consensus, and do so in a way that is both candid and respectful. You’re looking to work with people who are eager to serve on boards and have a track record of staying on boards for the long term, even after their economic interests are significantly diminished.
You’re looking to work with people who CEOs want to call first in times of crisis. You’re looking for professionals who are serious about their work, take fiduciary responsibility seriously, and know that there will be inevitable ups and downs.
#5. Understand Previous Cycles Behavior
Find out about previous economic crises through which they’ve invested. Have they or their firm been investing through multiple cycles?
#6. Mind Your Valuation
Don’t choose the highest valuation term sheet.
Fundamental-driven investors will care about valuation, and will be aligned with you to achieve a great outcome, whether it’s a private exit or a larger public event.
Make sure the pricing is far north of fair. You’re creating a future challenge for yourself, as it will be more difficult to grow into it for your next round, and your investors may not have enough skin in the game.
It’s no coincidence that these same momentum investors who offer astronomical valuations when things are hyped up will be the ones behaving like sheep and running scared when conditions turn.
If your company hits a challenging time or the market turns, these investors will likely be the ones to propose a punitive valuation in a future round, spend less time focusing on your company, or not be there for additional investments when you need them most.
Be Careful Who You Dance With
As Chuck Prince, Citi’s former CEO, said before 2007, months before he was forced to resign: “As long as the music is playing, you’ve got to get up and dance.”
We all know how that story ended.
At some point, the early-stage investing music will stop, and many people will be rushing off the dance floor.
Your company is too valuable to leave it to chance. When choosing a partner to drive growth, choose a firm that is focused on long-term, fundamental value—and will be there regardless of the weather.