What to Do When Markets Crash

I’m writing today from San Francisco. As my Co-Founder Adam told you in his last article, we just finished hosting our inaugural Startup Investor conference.

It was an interesting time to gather our (paid) members in one place. And it was hard not to notice – amid the air of excitement – an underlying tension.

Our members were clearly worried.

Not surprising. The stock market had been plummeting and the day of our conference – Monday – was the worst among a batch of bad days.

A few members wanted to know what I thought. We had some interesting one-on-one discussions. But in the Q&A following my speech, I was surprised that some critical questions on how this affects the risk and reward of startup investing weren’t asked.

So today I’ll ask them myself and then give you my views…

Will the current market downturn hurt startup shares?

Yes, if it persists.

Late-stage startups won’t want to IPO in a down market. Justifiably so. They won’t be able to raise as much cash or make as much profit.

This is a bigger issue for late-stage pre-IPO investors than it is for early investors (and founders). Early-stage investors would probably see a handsome profit regardless.

Since startups would prefer not to upset their late-stage investors, they’d be putting off the big IPO cash-out events until the market substantially improved.

The longer wait would hurt demand and dampen price at the pre-IPO stage. And the stronger possibility of a forthcoming down IPO round would also hurt prices.

Eventually, you can expect these lower prices to trickle down from the later to the earlier stages. Why? Because startups want to raise money at high valuations – but not so high that it makes getting a bigger valuation at the next round almost impossible.

So what founders and their investors see happening to valuations in the later rounds would affect how they price valuations in the earlier rounds.

Adding all these factors up, a prolonged correction in the public markets would likely lead to a less sharp and less sudden correction in the private markets…

But a correction nonetheless.

And this would not be such a bad thing.

Listen, prices in the private startup market have gotten somewhat elevated. As prices go down, it will make startups more attractive, especially for early investors.

They have to wait between five and 12 years for their startups to mature into IPO candidates, in any case. By that time the downturn will be long over. And the ultimate value of your startups should be unaffected.

The only difference is, you would have gotten in at a lower entry price.

How do new startups founded in the midst of major market downturns do over the long haul?

The historical record shows they do just fine. Take a look at this chart…

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As you see, in 2007 – when all hell broke loose in the U.S. and global markets – the startup space produced Dropbox (now valued at $10 billion) and Fitbit (now valued at $8 billion). Airbnb ($25.5 billion) and Cloudera ($4.1 billion) were founded in 2008. And 2009 was when Uber ($51 billion), WhatsApp ($19 billion) and Square ($6 billion) launched.

Going back to the dot-com crisis, the year 2000 saw Pandora ($3.4 billion) and TripAdvisor ($13 billion) get their starts. Guidewire ($3.7 billion), Bloom Energy ($2.9 billion) and SuccessFactors ($3.4 billion) began amid the market chaos of 2001.

And the huge successes of GoPro ($6.5 billion), LinkedIn ($23.3 billion) and SpaceX ($12 billion) had their origins in 2002.

It’s pretty clear: Down years for the public markets do not prevent startups from becoming billion-dollar (or more) businesses.

Great companies are created every year, regardless of the circumstances of the public stock market.

And I would suspect these companies also had an easier time hiring personnel, finding cheap space and controlling costs than companies founded in years where equity capital was plentiful.

And if investors can invest in their seed stage at lower prices, then all the better, right?

How will crowdfunding (CF) itself be affected?

Will slightly lower seed and post-seed prices keep CF funds flowing?

Historically, as stock prices plummet, equity investing turns to safer assets such as bonds. Or they turn to gold to protect against catastrophic scenarios.

But could a volatile stock market push public equity investors into the private startup markets instead of into bonds and gold?

Crowdfunding is so new there are no historical guidelines here. But to me, it makes sense for money to flow into markets where prices aren’t making huge runs (both up and down)…

To where it’s more likely that good companies will be awarded with higher valuations – because shares are illiquid and not subject to the daily whims and white noise that bombard the public markets. Whims that can cause huge shifts in sentiment and momentum from week to week and even day to day.

Which means it probably won’t happen. As it stands, only 3% to 3.5% of the 8.5 million accredited investors in the U.S. invest in startups.

More fear and less liquidity would most likely translate into less CF capital going to startups.

And that’s a shame. There is no reason for early-stage startup investors to panic or become less willing to engage in the startup investing space.

But I suspect my words will fall on deaf ears. Fear is contagious and reason often loses out.

To the detriment of investor returns, in this case.

Invest early and well,

Andrew Gordon
Founder, Early Investing