Eric Rosenfeld – October 2018
Preparing for the Inevitable Downturn:
The three "C's" when flying a plane…and discovering you are lost.
Advice from entrepreneur/VC Gerry Langeler
We invited Gerry Langeler to meet with us and share his advice on what the Oregon Venture Fund and our portfolio companies should be doing now to prepare for the inevitable next economic downturn.
Worth remembering that during the mortgage meltdown and the ensuing Great Recession (12/07 to 6/09), the Dow Jones Industrial Average lost 50% of its value. Venture financing dollars dropped 40% and the number of initial venture financings also dropped 40%. 9 million jobs were lost. $7 trillion in home equity evaporated. 7 million American families lost their homes.
One of the few silver linings of the Great Recession was the measurable surge in entrepreneurship. New business starts hit record highs (Robert Fairlie, UC Santa Cruz).
During that difficult period, the Oregon Angel Fund (our original name) was well positioned to back both “entrepreneurs by choice” and “entrepreneurs by default.” Our investors and many of our entrepreneurs were well rewarded. A few of our initial investments, and their associated returns, during the Great Recession included: Elemental Technologies (8/07; 12X), Lumencor (9/07; 14X), Jama (1/09; 37X), and Giftango (9/09; 6X). What did these startups all have in common? All were (a) capital efficient, (b) B2B, and (c) solving critical problems for customers (selling “aspirin,” see below).
Gerry Langeler co-founded Mentor Graphics in1981; 3 months later the US economy entered a 16-month recession. Nevertheless, Gerry and team grew Mentor into the most valuable SW company in Oregon history. Gerry Joined OVP Venture Partners in 1992, on the heels of the 90-91 recession, where he invested through both the DotCom bust and Great Recession. He received OEN’s Lifetime Achievement Award and currently co-chairs the Oregon Growth Board. Gerry is an ideal person to weigh in on lessons learned from the DotCom Bust and the Mortgage Meltdown and what we should be doing now to prepare our fund, and our portfolio, for the inevitable next economic downturn. Here are our notes…
The 3 C’s from Flight School. Goal: keep you alive…while flying:
- Climb – Raise & husband cash to increase altitude, flight time.
- Conserve – Reduce spend to extend run time
- Confess – Communicate early, openly to maximize help
Warning signs of an impending crash/recession:
- “It’s different this time…” A red flag event that people discount.
- Speculative investments in businesses that don’t make financial sense.
Advice for funds in advance of an economic downturn:
- Economy can deteriorate fast: 3-6 months. Then you’re stuck.
- Reserve 3X initial investment for follow-on.
- Portfolio review – focus on changes in CESIT: Cash. Execution. Space (competition/market; future investors/buyers). Investor Group (adding value? checked out?). Team.
- CEO-a-thon: Each portfolio CEO comes in for 1 hr presentation. Plan? Issues? What are you doing now to prepare for a downturn? Rank all on a curve and identify outliers on either tail.
- Assign 2 partners to each deal. The backup partner plays the “jerk” or Cassandra, asks the tough, worrisome questions. Balances the primary partner, who understandably has pride of parenthood.
- Ask portfolio companies to show cash projections based on…
1. No revenue (a downward sloping straight line)
2. Plan of record (an optimistic J curve)
3. What they think now (realistic J curve)
- Invest in startups selling “aspirin” (directly addressing customer pain; mission critical; ideally “addictive”), not “vaccines” (prevent possible future pain), not “vitamins” (helping customers do better; nice to have), and definitely not “candy” (consumer discretionary/luxury).
- Be a valuable partner to our out-of-state co-investors; lever our relationships.
- Ensure sufficient capital reserves during a downturn, when deal flow could mushroom and valuations drop.
Advice for funds during a downturn:
- Our job: keep management teams alive
- Triage portfolio – focus on funding top 50%.
- For which companies would their thesis still hold, and the market window remain open, if their runway is extended and product releases delayed 6 -12 months?
- “We (OVP) were wrong with every deal where co-investors didn’t participate.”
Advice for companies in advance of a downturn:
- Never feels like a good time to trim underperformers, so do it now, before too late. Don’t wait.
- Build reserves; establish/renew line of credit; cut fat.
- If fundraising, raise more than you need.
- Sell if you have a motivated buyer; bird-in-hand…
Advice for companies during a downturn:
- Great time to focus on product dev – customers have time, but not budget.
- “Climb, conserve, confess.” [see above]