On the heels of her conversation-driving Twitter thread on 2020’s venture fundraising climate, Hustle Fund’s Elizabeth Yin converted her thoughts into an op-ed for TechCrunch. In keeping with her expansive thread, we asked her to adapt her thread for a TechCrunch column and join us for an extended conversation.
What follows is an interview between Yin and myself that came after I read her piece (which you can find here), digging into venture capitalist fear, the ability of established founders to raise outsized rounds, her advice on growth and how some Series A and Series B-stage companies posting impressive revenue expansion might be nigh-unfundable in this, the new fundraising reality.
What follows is an edited, occasionally condensed transcript of our chat. Let’s go!
TechCrunch: Okay, question one. You said, “VCs have gotten scared, almost to a fault.” Aside from the WeWork IPO implosion, what are the leading drivers of this recent increase in fear?
Elizabeth Yin: Taking a step back, I think we have to ask ourselves, what is even the place of venture capital in the first place? And when you think about the original venture capital industry, you know, decades ago, those VCs were taking big, big bets, like at those moments in time during the 90s, or even before that, for some of the chip companies or even Apple Computer, there were many bets happening there.
If you had to segment it: there were markets, there were technical bets. And basically a combination of all of the above. Like, could you technically build the Apple computer? And was there a big enough market for it, etc. So VCs, when you think about it, were taking a lot more risk back then. Because back then, you actually needed a lot of technical know-how to even be able to set up servers or, or build, you know, huge undertakings of devices, etc.
These days, frankly speaking, a lot of the risk is already off the table for most software VCs. Very rarely am I looking at a startup and thinking, “I wonder if the founders can actually build this website,” because in many cases, a lot of the building blocks to be able to do so are pretty streamlined and straightforward.
You still obviously need to be a pretty good engineer or product person, but I think it’s just a lot easier now to remove some of the risks, including technical risk — and in other cases, market risk is also removed in cases where a company may be trying to just replace another company that is already a big behemoth, but may not have a great user interface or whatnot.
So I think if we kind of look at how VC has evolved, it’s evolved over the years where VC today, I would argue, in software, at least, don’t take a lot of risks.
Most B2B SaaS companies are even less risky than some of the other bets, such as some of the scooter companies, where there have been a bajillion marketing software companies that have been built and have turned out to be big, but scooters are relatively new, who knows if that will end up being a big company. But I think you’re seeing even more of a shift to take even less risk. And I think that’s interesting about this time.
So there’s been a decrease in risk tolerance, which I call Increase in fear. I think the WeWork implosion, when the S-1 dropped through the kind of the IPO cycle that ends up being pulled, is generally called the catalyst for this. But it doesn’t seem to be enough.
Are there other things that have happened in the last maybe like six or nine months that have led to this either increase in fear or decrease in tolerance?
I would point to Uber as well. And I think if we’re going to kind of blanket statement it, a lot of people have been looking at SoftBank’s Vision fund, just in general and looking at some of their investments that may not have gone very well in the later-stage markets. And if you had to further blanket statement here, it seems that there are companies in certain categories that people now feel were not really meant for VCs to get involved with.
And those tend to be in areas like marketplaces, or they tend to be in areas that are very capital-intensive, such as WeWork, etc. And so I think people are kind of looking to all of that as an overall change in how they think they should think about things.
You said in the piece that you’re seeing “Series A and Series B companies with 30% month-over-month growth that were popular before are currently struggling to raise rounds, because they’re not profitable.”
Do the companies that you just mentioned — the marketplaces and maybe e-commerce players — fit into that box? And if so, are they uniquely unprofitable to the point today and just become essentially unfundable?
No. And so this is where I think the pendulum of risk tolerance kind of swings back and forth. At least in my view, there are many hot companies in, let’s just call it marketplaces in the e-commerce category a year ago, a lot of VC guys thought, “these are good investments, let’s fund them, let’s invest in them,” where they’ve continued to grow on the trajectory they were on even a year ago.
But now, because people’s mentality is shifted a little bit just having seen the late-stage market reactions to some of the IPOs — the Uber IPO, or, or the reaction to WeWork trying to IPO — I think there’s now this new fear of, ‘“oh, gosh, maybe the public doesn’t like these kinds of companies, or maybe later-stage investors to me won’t like these companies.”
Since I need their capital to continue funding my companies, maybe these are not investments I should be in — and that has a trickle-down effect all the way to early-stage companies. So there’s nothing really fundamentally different those companies everybody thought were pretty interesting last year, to this year, they continue on their trajectory. But e-commerce and marketplaces are not hot or interesting or as interesting as before, and so there are fewer people who want to be throwing money at those, and therefore it’s just harder to raise money if you’re one of those kinds of companies.
Going back to your point about SaaS being very fundable both in the piece and what you said a few minutes ago, because the late-stage and IPO market for SaaS companies is relatively good. I presume that’s driving the extra interest of the earlier stages for SaaS companies today. Is that fair?
Yeah. So I think there are a couple of drivers for that. I mean, I think if you look at some of the late-stage SaaS companies like some of the ones that went IPO last year, or even if they didn’t go IPO, but have raised later-stage rounds, I would just say as a blanket statement, many of those have done phenomenally well. Those ideas generally went quite well.
If you look at Zoom, that’s great. The second component is looking at their characteristics of “oh, well, with SaaS, the margins are high and the upsells can be good and the retention as well.” So therefore, just from a business mechanics perspective, even if other funders are not interested in pouring money into my SaaS companies in my portfolio, they can still make their business survive and thrive and really grow fast, even without a lot of capital.
So I think combining those two things together, then VC just think, “aha, well, maybe I should go into SaaS.” And I think just, you know, I’m not talking about people who were strictly in marketplaces before now going strictly into SaaS. But I think, you know, a lot of software investors are generalists. And so, you know, people may start to favor doing more SaaS investments than you know, marketplaces or e-commerce.
One of the things that you mentioned is that raising in San Francisco is very hard. People think it’s easy when it’s really, really not. And you said there’s more funding there, but there are also a lot more startups.
And so I’m kind of curious, for early-stage founders looking at this kind of more profit-focused world, would you ever recommend an early-stage company, maybe around the seed stage, move into San Francisco today? Or would you generally recommend that they stay in their home market and build from there?
That’s a great question. And I think, like everything else, it really depends. There are a couple of things happening — one is that you see the rise of other ecosystems outside of San Francisco, and there are particular ones. So for example, one of my favorite ecosystems to scout in for startups is actually Toronto.
And Toronto, you know, has had a number of companies come up, I think Shopify being the most notable. There are a lot of alums from Shopify, but also from Google and Facebook spinning out and starting their own companies there. And so they have an ecosystem that is really growing and thriving.
I think they’re a great example, but there are, of course, plenty of others in the lower 48 states as well. We all know them: Boston, Seattle, Austin, Denver, Boulder, New York, of course, LA, etc. So I think you see a lot more cities just really growing their startup ecosystem.
Now, it’s unclear that you necessarily need to move to San Francisco, at least at the earliest stages, because you can get a lot of advice within your city, as well as online in most cases. A good exception is that they’re obviously a lot of really, really small cities in the U.S., and I think if you’re trying to build in a small town, it may be worthwhile to move to a larger startup ecosystem that’s nearby. And so I wouldn’t necessarily say move to San Francisco, but I would move to a place that has a thriving startup ecosystem, at least at the earliest stages.
In the later stages, it is worthwhile to move to San Francisco because as you’re growing your company, there are a lot more people in San Francisco who have built high-growth companies before, there’s a lot of knowledge that I think is still insider knowledge in San Francisco itself. But at the earlier stages, I don’t think that that’s necessary.
And then the flip side is San Francisco itself has a lot of problems with housing and cost of living and all this other stuff, that make it pretty cost-prohibitive for a startup founder who has no money to be able to have enough runway to really make an early-stage company work out. And so I think those are kind of all the tensions and why San Francisco is less interesting than perhaps 5-10 years ago.
One thing that you talked about at the start of the piece was the discussion about how for certain founders, it’s very easy to raise. And for other founders, it’s very, very hard. And you talked about how for some people with very established records or resumes, they can kind of command outside-the-scene face valuations and outside seed-stage raises.
You also noted that founders who raise a lot of money often struggle to raise later on; why are people so willing to put large amounts of money to work in these well-pedigreed founders if they tend to struggle later on? Haven’t investors caught on to that trend in those deals?
I think there are a couple of tensions here. One is if you’re trying to look for patterns as to who does well, it is still true that a lot of the unicorns that you see coming out all have a certain kind of resume, like maybe they went through YC, or maybe they graduated from Stanford, or maybe they’re ex-Facebook or Google, or maybe some permutation.
I think a lot of that is still true. But… it’s hard to say whether it is actually helpful to have that on your resume. I personally don’t believe that actually helps you build a successful company. But I think a lot of people just sort of erroneously look at the results and not who doesn’t make it. That then drives who ends up getting funding, because people then see all the people who built the companies all tended to come from like a FANG company, or they went to a certain school or whatever.
That’s just sort of not looking at the data properly. But that happens a lot in this industry, ironically. So that’s number one. And number two is, to a certain extent, people who come out of some of these institutions have already been filtered, in the sense that if you were an engineer at, let’s say, one of these FANG companies, hopefully that is a signal that actually you are pretty good at engineering, because you’ve gone through all the rigorous engineering interviews. In this day and age, where what we talked about before in core businesses these days, unlike, say, 10 years ago, you actually don’t need to be the most brilliant, technical founder for most generic software ideas. I think that you need to have good user experiences and things that customers like.
But that doesn’t mean that you need to have a certain level of knowledge in the way that you did 10 years ago. And I think even further back, like if you need to build your own servers, and there was no information on the web about how to even build a website, the differences between building a company back then and building a company now actually doesn’t mean that you need the same level of skills or knowledge now as you did back then.
So the market has evolved in terms of what it rewards more quickly than venture capitalists have amended their pattern recognition or models that they use to invest. And there was a mismatch between how to put capital to work efficiently in certain deals with certain countries and certain countries. I mean, that just sounds right to me, frankly.
Yeah, I think those are the two biggest drivers. But the third one is just networks. Networks, I think are starting to be pulled apart a little bit. But certainly, you know, if you worked at one of these FANG companies and you know, like the co-founder of your company and they’ve done well, they will likely put money into your startup because they know you and they like you. And they’re investing because, you know, you’re their friend or whatever.
In these networks, if your friends have money, then it’s easier to raise money… so that’s that third piece of more insular networks, you’re starting to break down that by the rise of accelerators. Like if you get into YC and you were a nobody before, then you automatically get elevated into a network that you didn’t have access to previously.
And once you get momentum on your round, because your friends invested, then that makes it a lot easier to close a round, even with people who don’t know you. So I think those are kind of three drivers for that.
Summarizing your advice to founders, it felt like you were saying “grow quickly, don’t lose too much money, and don’t raise too much money too quickly.” I know that’s way too broad of a stroke to kind of summarize your whole piece, but it felt like you were almost advocating for a more historically normal venture cycle with people taking risk, but not insane amounts of risk and not trying to raise all the capital in the world when they’re still like, you know, pre-revenue.
Are we just getting back to like a more normal venture capital market after maybe a five-year period a lack of discipline?
As a very early-stage VC, of course, you know, this is self-serving advice. But I also think that with my founder hat on, it is what founders need to do. Because as a founder, when you don’t know exactly what you’re building for which exact audience and how to get these exact people, there’s a lot of experimentation that needs to happen. And throwing $3 million into a problem at that stage is not going to help you solve that problem any faster.
I think to a certain extent, putting money into faster experiments helps, but it only goes so far. You can’t drive speed of execution with money; it happens through the speed of learning. And I think that’s something that there’s an upper bound as to how much and resources you can put into increasing that speed of learning in the earlier stages.
And so I think, I’m very fearful that and, you know, we’ve got a number of founders in our portfolio also who have raised like, say $5 million at the seed and my hope for them is that they will be very cautious with their money during this experimentation phase and not burn it too quickly.
The companies that we talked about that were growing very quickly, and the companies that are out of favor in the wrong categories — do you think they’re going to be able to reduce their growth rate and burn sufficiently to survive until they either come back into favor or they’re improving profitability and making them attractive again?
So one, I think there are investors in the Valley who are truly contrarian and will pick up on this arbitrage opportunity. And so I think that very good, let’s say marketplaces, are e-commerce businesses, even if they’re not profitable, but they’re growing quickly.
They may take longer to raise to find those investors. We actually don’t do a whole lot of marketplace investments and we don’t do any e-commerce investments, either. If we did, that would be probably the first category I could try to put my money into, because it’s always better to go where other investors are not looking and they’re still great companies.
We will also see startups in those categories die where if they had access to just a tinge more capital, they might have made it. But this is where I think you see separation of the savviest entrepreneurs from kind of everyone else. And I think part of being savvy is also being frugal or effective with your money, too. So we’re not going to see all marketplace or all e-commerce companies die, for sure. I mean, every economic state, like they’re always winners, and so I think it’s just even more important for them to be cash efficient.
But I do think it’s more challenging for a marketplace or an e-commerce company to have that growth and be profitable. And that’s going to be a challenge just in general for the category.
Your line about how VCs want to invest in both companies that are high-growth and profitable and like you know, who wouldn’t? That takes the venture out of venture capital.
Yeah, well, I mean, we’ve seen this ship, right. Like, I think if you just look far enough back, like if you look at Apple Computer, and if somebody came to you with that as a napkin idea, I think there are very few VCs who would want to back that business.
With the rise of SaaS, mechanical knowledge of different metrics, ratios, expectations and growth rates becoming kind of standardized, it seems like people want to de-risk venture capital entirely. They want companies to just fit a certain model or curve, and then they know they’re guaranteed success. It’s almost done remarkably less adventurous you know, less cowboy, ask less.
I think on that last point, if you play this out further, like what happened, let’s just say to SaaS startups. Well, it’s interesting because I think you’re gonna see a couple of things happen: one, as long as VCs are going after the same SaaS startup. And granted like these days, I would say that the market for SaaS startups has expanded but, I think it’s going to be more competitive for VCs to get in SaaS companies and you see valuations go up even further even though the multiples are already quite high. Yeah, so that’s number one.
But then number two, I think the other thing is for the savviest SaaS founders — especially the ones that with a fair bit of traction, where there’s a level of predictability — they can see that their retention is strong, their upsells are good. And you’re just talking about I just need some working capital to basically pay for my customer acquisition, and that’s going to pay back in like two months or whatever, the savviest SaaS founders are not going to go to VC because they’ll realize that venture capital money is incredibly expensive when you think nothing is free, when you have that big exit, VCs will make hundreds of multiples over on their money in a great business.
And those founders if they had seen that predictability from the beginning, they wouldn’t need to take that extensive capital. They would then go to get a debt line or revenue-based financing sort of debt. I think we’re now starting to also see the rise in those funds, as well, competing for the same business. So you’re just going to see a bloodbath, not just amongst VCs there, but, but you know, other types of funders.
And then I think even arguably, some of the companies like, you know, brax, has a credit card, and you can get a 60-day, interest free loan, essentially. And so if you have customers who pay you back, like fully within 30 days, that’s a no-brainer, you just borrow capital constantly for free, and just fund that customer acquisition. So I think we’re going to see a lot happening in alternative financing as well.
I’ve been tracking the rise in revenue-based financing, venture debt and other things like term loans, various kinds of repayment functions. And to me if you’re a SaaS business post-Series B and half your next raise isn’t some form of debt facility, why would you take on extra dilution when effectively that’s when you would have spent the money anyways?
And this cuts out some VCs from the rounds, which probably makes the competition higher, which will lead even higher prices, ironically, and then we’re going to end up with what 30 – 40x ARR multiples I mean, I am perplexed at how we’ve gotten to a roughly 13x multiple on public cloud/SaaS companies as a group, and some are at a 20-25.
Even as a SaaS optimist, I do not understand those prices at the early stage, they can be even more stretched. So I mean, how much more room is there to go? I would have said “no more” two years ago, but I would have been flat wrong. So I don’t want to put a cap on it. But I see what you’re talking about and the tensions that you’ve described. I just don’t know what’s going to happen.
Yeah, exactly. So to your point, I mean basically like valuation supply and demand right. So if, let’s say debt providers take up now half the round or third of the round. That’s like a third less supply for investors like VCs to be investing in. So that will create, you know, an even greater rise in valuations to your point. And I agree with you. I think right now, it’s quite pricey. I don’t love that as a VC investor, but I think that’s what’s going to happen.
Read Elizabeth Yin’s guest post, The fundraising landscape is shifting in 2020.