Thoughts on the Sequoia Deck

Two things really struck me after reading the "RIP Good Times" deck that Sequoia Capital presented to their CEO's at an all-hands meeting last week.

First, the extremely well-done and convincing frontispiece. Looking at graph after graph of macro-economic data, one gets the overwhelming feeling of inevitability.  Of course this crash happened. Look at the numbers!  Rising consumer debt. Falling wages. Ballooning home prices. Diminished savings. Risky lending. Insane derivatives vehicles. Out of control deficits. Jeez. If it seems so inevitable in retrospect, why didn't anyone (other than Paul Krugman) see it coming? 

I'm not suggesting that Sequoia's economist are overstating the challenging nature of the current economy and the factors that got us here; rather, I am shocked that these economists weren't advising their banking and hedge fund friends to reduce leverage, anticipate the sell-off in equities, and prepare for 1929 all over again. Guess the money was too good.

Second, look at slides 46 and 47.  The "what should our CEOs do" slides. On slide 46 they admonish their CEOs to create must-have products with clear revenue models; understand consumer's ability to pay and the alternatives available from competitors; conserve cash and focus on profitability. On slide 47 they suggest an ops review in which the CEOs should focus on cutting unnecessary G&A and production costs, being realistic about closing business, developing only necessary product features, and seeking a return on invested operating dollars. Maybe I'm missing something, but isn't this what CEOs are supposed to be doing in ANY market?

That the very smart people at Sequoia, one of America's leading venture firms, feel that they have to tell their CEOs to ... well, to act like CEOs, tells me something about how much we've forgotten since the dot-com bubble burst and how much we all have been seduced by non-businesses (but ones with lots of users!) in the post-bubble web 2.0 froth.

Culture of Thrift

One of my mantras as a business unit manager and as a CEO was the importance of creating an organizational culture of thrift.  A lot of CEOs pay lip service to cost control, but don't really run their organizations with thrift as a fundamental value.  I think that is a terrible mistake.

In organizations that are succeeding, there is the tendency toward carelessness in spending. It's not outright, intentional waste; rather, it is just a willingness to let things slide and an assumption that it's not worth the pain to micro-manage everything. And so, the myriad of little expenditures run together into a flood of budget-busting costs. Conversely, running a thrifty organization means actually looking at every dollar that is being spent and thinking about the value that dollar of spending is generating in return.

Thrift is not simply cost-cutting. Many times, cutting costs is just not wise. It constrains the organization and prevents growth. But anyone who has managed a medium to large organization will attest to the fact that a lot of money gets spent on things that don't really matter to the success of the company. 

When I was younger, and dumber, I used to think you could create simple bonus incentives for managers to cut spending. But that didn't work -- managers would just say no to any project, regardless of how vital, in the interest of bonus maximization. That's where the culture of thrift came in. Instead of making the dialog about cutting, you shift the dialog to "how can we derive the most benefit from the smallest expenditure." 

Here's a great example: in the summer of 2006, Nanea Reeves and I assumed responsibility for the online platforms at Electronic Arts. I won't go into the details, but trust me -- at the time we took over, it was a mess.  We had to make a very sharp break with the past. Unfortunately, there was already a large team in place, a lot of spending in the pipeline, and a lot of risk aversion to going a radically different direction. Yet, everyone acknowledged that the platforms were broken and EA's future competitiveness would be compromised if we carried on with the existing plans.  Stalemate.

The typical way things go at EA (a company that doesn't have a trace of the culture of thrift in its DNA), you would figure out the product features and then bargain with your boss about budget. Nanea and I didn't do this -- we applied our culture of thrift thinking to the problem. We looked at the current budget and said, "How do we get what we need without any additional spending -- just by using the earmarked dollars in the budget?" We could do it, but it required firing a large number of people who were not useful to our strategy -- perhaps up to 75% of the employees in the group. It required outsourcing. And we explicitly put on the table the end of our department at the end of our project: when we finish, we go away. No empire building. No busy work. No inertial spending.

We got resistance at every level -- while nobody wanted to expand the budget to cover our new strategy, at the same time the EA culture fought us to retain unnecessary employees, continue funding quixotic projects, and not rock the boat. I kid you not: the then-CEO of EA actually interceded to question the wisdom of firing one of the low-level producers, because "he heard she was good." That's how unpopular a culture of thrift can be in an organization that is used to wanton spending. Ultimately, we prevailed, and on a recent earnings call, the now-CEO of EA actually spoke about our new "Nucleus" platform as a bedrock competitive advantage of the new, improved EA.

That's the essence of the culture of thrift. Do more with less. In this environment, it is the skill set that will separate the winners from the losers.

Fite Dem Back

I've been listening to a lot of Linton Kwesi Johnson lately. For those of you who don't know him, LKJ was a British dub poet of West Indian origin, who recorded several amazing and incendiary reggae albums in the late 70s and early 80s. LKJ is, sadly, the perfect soundtrack to the current political and economic circumstances.

LKJ was at the height of his powers as a poet during a time of tremendous racial strife in England, with the anti-immigrant National Front on the rise, and frequent acts of violence perpetrated against blacks and Pakistanis by dead-enders and skinheads, and more subtle institutional racism perpetrated by the police, through the infamous "sus" laws. LKJ took on the racism of British culture with calm fury that still resonates as clear as a bell today.

Earlier this year, with the war still raging and the Democratic primaries in full swing, I was attracted to the dark, apocalyptic tones of "Time Come," with its rock-steady beats and lyrics of dire warning. Later, over the summer, I spent more time listening to his incredible "Independant Intavenshan" with its passionate call for personal political action, against a backdrop of jaunty horns.

But in the last couple of weeks, as the Republican demagogues have unleashed the race-baiting, xenophobic anger of the extreme right (and particularly the "Christian" conservative base), the song I keep gravitating to is LKJ's "Fite Dem Back." To wit:

Fascists on the attack!
No botha worry 'bout dat
Fascists on the attack!
We will fite dem back
Fascists on the attack!
We will countah-attack
Fascists on the attack!
When we drive dem back
We gonna smash they brains in
'Cause they ain't got nothin in 'em

This election gives us a clear chance to repudiate the toxic brew of hate and ignorance that passes for populism on the extreme right, and perhaps to end the unholy influence of evangelical christianity over the Republican party.

In times like these, when fascist cops can get on stage and spew thinly-veiled race hatred with impunity, we have a moral duty as Americans to fite dem back. To smash them. To demoralize them and end their power as a movement.

Veep Debate Redux

I actually found the vice-presidential debate more enjoyable than the presidential debate.  In place of the grouchy dickhead McCain and the aloof, bloodless Obama, Palin and Biden seemed like nice, normal people.  

Palin held her own, didn't try for too many scripted zingers, and, after a shaky start, seemed to relax into the moment.  I expected her to over-perform expectations, so her good performance didn't really surprise me all that much.

Biden was better than I expected -- more substantive, less windy, and as genuine as a guy who's lived in the Senate his whole adult life can possibly be.  He kept his answers short.  He was respectful of Palin but critical of McCain.  He walked the tightrope well.

Gwen Ifill, the moderator, was a train-wreck.  She failed miserably to keep the debaters on the question at hand, and let them wander all over the place in their answers.  

Who won?  Who cares.  Unless Jesus Christ walked into the auditorium and endorsed Palin, her performance wasn't going to change the game much (perhaps, as I expect, it will stanch the bleeding somewhat, and keep McCain at -6 to -8% over the weekend).  Biden reinforced the cool competence of the Obama campaign, without making too much trouble.  Unlike the punditocray, I think it was a draw, and the draw benefits the leader.

The best moment for me wasn't really anything either of them said, but rather it was the warm, cordial moment when they brought their families on stage at the end.  Huge contrast from McCain snubbing Obama by not looking at him, and the robotic Cindy reaching out to shake Obama's hand like she was removing moldy cheese from the refrigerator.  The families seemed at ease with one another on stage, and it made me like both of the candidates more. 

Entrepreneurship in Tough Times

I think it's too early to assess the real impact of the Great Wall Street Meltdown of 2008 on the venture community and on the startup companies we fund. One thing seems clear: with the IPO market disappearing and the M&A market effected by the diminished currencies of the potential buyers, the exit opportunities are certain to be attenuated.  The blowback from this attenuation -- and an overall reduction in risk tolerance by investors across the board -- will likely take the fun out of fundraising for a while.

This will also have an immediate and palpable effect on pre-money valuations. Venture tolerance for risk is deeply entangled with our ability to acquire ownership, the price we pay for that ownership, the cost to maintain that ownership over time, and the availability of exits.  If the market for follow-on financings gets soft, and it takes much longer to get companies liquid, then we will have to assume greater downstream dilution, or increased and prolonged pro-rata investment to maintain ownership, with the increased risk that brings.

The really hard-sells in this environment are typically the "build an audience and think about business models later" plays.  These companies are generally hit the hardest by the diminishing venture risk-tolerance. I'm not sure this is entirely justified, particularly if the company has a low burn rate, but the rationale seems to be that it's harder to flip these no-revenue plays for their strategic advantage alone (vis YouTube) when the buyers' currencies get whacked, and it's impossible to take them public in a contracting market focused on economic fundamentals.  

But it is not all gloom and doom.  I have personal experience launching and managing a startup to success in the last downturn. JAMDAT raised its first round of venture investment in early 2001.  We raised a series B in 2002 and a series C in 2003, before going public on the heels of Google in October 2004.  So I have some scars from financing a company during times like these, as well as the pleasure of seeing it all work out in the end when the market recovers.

Based on that experience, I want to offer three lessons from the JAMDAT playbook for entrepreneurs dealing with a the fear-tainted venture capital environment:

1) Focus the burn.  I am not arguing for lay-offs and contraction, hunkering down in the bunker with canned goods and ammo. But you need to be spending every dollar you have in single-minded pursuit of the things that are going to increase shareholder value and the likelihood of future financing. 

We kept JAMDAT at around 30 employees and a $400K burn for two and a half years, until our revenue model became clear.  If the team needed a feature and we wouldn't fund it, they got creative -- outsourced to India, formed partnerships with independent developers. We grew expenses and headcount in response to actual financial opportunities. 

There were some tough times -- the US carriers delayed launching the services that enabled our business by 6-9 months (which was the blink of an eye for them, but devastating to our carefully-managed cash position).  You have to plan ahead -- getting caught with no cash and having to appeal to your existing investors for bridge financing, or having to raise money when you are on your knees, is a recipe for entrepreneurial disaster.

2) Manage for Long-Term Competitive Advantage.  This is not the time to be chasing every possible tangential business opportunity, or funding pet projects and speculative R&D. This is the time to pursue your chosen strategy with insane focus. We used to evaluate everything we did at JAMDAT with the following question: is this going to create long-term competitive advantage for our publishing business? 

We were pursuing a risky strategy -- it assumed that color screen phones with embedded operating systems and bill-on-behalf models would predominate in the cell phone markets in the US and Europe.  That was non-obvious in 2001/2.  But we were right; and the fiscal discipline and strategic focus that we embedded in our DNA during the uncertain period allowed us to get to profitability and market dominance rapidly after the worm turned.  We had eliminated all the fat and distraction, and we were able to execute much more efficiently when the business took off.

3) Don't Fool Yourself.  Raising money in these environments really sucks. In the spring of 2002, we initiated our series B -- a full 8 months before we were scheduled to run out of cash. Just to be on the safe side.  Every tier 2 and tier 3 VC we pitched announced that they were "only doing down rounds."  We were literally thrown out of one VC's office -- asked to eat the lunch that had been ordered for us elsewhere -- because we had the temerity to suggest that, having funded JAMDAT at a post-bubble valuation and having shown good progress, we should not be lumped in with gardenhoses.com, or whatever other dead dot-comedy they may have funded in the 1999 greed-orgy.

The key is that you have to be honest with yourself about your business. You have to talk the talk and walk the walk on risk reduction and focus.  You have to be honest about your opportunity.  In this environment, you won't be getting away with top-down, "if-we-only-get-1%-of-this-huge-market" fantasies, or bullshit pro forma P&Ls with 70% EBIT margins in year 3. 

The VC who kicked us to the curb was an idiot -- he was so focused on the deal that he couldn't see the opportunity. That happens a lot in these funding environments. But don't blame the VCs for seeing through your bad business, either.  An investor may have the stomach to take a flier and see if it works out in a frothy market, but not now.

Dangerously Unfit

If you thought I was stretching when I questioned McCain's personal narrative and described him as the callow beneficiary of nepotism and favors, read Tim Dickinson's new article in Rolling Stone. If anything, I understated what an asshole he was and is.  If Obama had received this much "affirmative action," he'd be answering for it every day.

Well, perhaps it just won't matter.  Looks like the pigeons are coming home to roost.  McCain is conceding defeat in Michigan, one of the few blue states he had a chance to pick off.  Now he can only play defense, hoping to stop the Obama machine from rolling him in Virginia, North Carolina, and Missouri, while he tries to put the math together to win with a bare minimum majority in the electoral college.

I think we'll be seeing a lot more of Jeremiah Wright, sex ed for kindergartners, and dead abortion babies in the weeks to come, as Johnny Pugilism hits the ropes for the last time.

Oh, and perky Palin wins the debate tonight if she manages not to fart, drool, or confuse Palestine with Pakistan.  Post-Couric, expectations are so low it is almost impossible for her to under-perform.  That said, she's got to be nerved out -- the pressure on her must be ridiculous. She's the last chance McCain has to reverse the tide at this point.

Biden is not exactly inspiring a lot of confidence, either. I attended an intimate dinner with Biden in LA last year, when he was cranking up his campaign. He's a nice guy, but boy can he spew bullshit.  Somebody asked him an ethanol question that could have been answered in one sentence, and he talked for almost 20 excruciating minutes.

I think the Hartford Courant had the best line on Biden v. Palin: that the audience is anticipating the debate with "ghoulish fascination -- like waiting for a crash at a NASCAR race ..."

The Fat Lady is Practicing Her Scales Backstage

I don't trust polls.  There are a lot of reasons, not the least of which is the tendency of polls to be dead wrong.

That said, if the current presidential election polling is correct merely in identifying the trends, our war hero buddy Johnny Drama is fucked.  Clearly, there is a lot of time left on the clock, and this could (and likely will) tighten before voters cast ballots in November. But this is some very, very bad news for the GOP.

Some context for you non-junkies:  Obama is currently leading -- comfortably in many cases -- in Florida (2004 Bush +5%), Ohio (+2.1), Nevada (+2.6), Virginia (+8.2), North Carolina (+12.4), Colorado (+4.7), New Mexico (+1), and Iowa (+1) -- all states won by Bush in 2004 by the margins in parenthesis.  CNN has Obama slightly ahead in Missouri, which Bush won +7.2%; and most polls have Indiana too close to call, a state where Bush won +20.7%.  

This represents an aggregate 123 electoral vote swing in favor of the Democrats. To give you a sense of how bad this is going for McCain/Palin, North Carolina hasn't voted Democratic since 1976 -- not even for Bill Clinton. Indiana hasn't gone blue in the last 40 years.  Bush won in 2004 with 286 electoral votes to Kerry's 252. Assuming the polls are correct and the leads hold (kind of a ludicrous assumption given past experience, but let's go with it), Obama beats McCain in a landslide, 375 to 163.  My own prediction is a lot closer: between 305 and 318 electoral votes for Obama to win the presidency.

Interestingly, the Obama camp said a week ago that the polls understated the power of their ground game. They believe that their registration of new voters (young people, African-Americans) is not captured in the traditional polling.  When this was first reported, it sounded naive.  Now it looks more plausible than ever.