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No Mercy No Malice

Down Round

February 25, 2022

A week of contrasts that mark the age: A Russian president launches the invasion of a sovereign nation ahead of schedule; and a (former) U.S. president can’t launch a microblogging platform on time. At least our innovators will keep inspiring us. My favorite headline this week: “Artist Blows up Lamborghini Huracan to Sell Videos of Shrapnel as NFTs.” But I digress.

What’s thankfully diverted my attention from the full-scale war in Europe is spelled out below. As in look out below. Way below.

These aren’t cryptocurrencies. They’re stocks — many of them, large-cap stocks. OK, there are a few meme stocks in there, but there’s a mess of good, even great, companies that have shed more than two-thirds of their market value: Paypal, Zillow, Bumble, Roku, etc. Aggregate the losses above and you get … $2.2 trillion. So the aforementioned businesses have lost the equivalent of the GDP of Canada.

History doesn’t repeat itself, but it rhymes. Check that — it is repeating itself. If you’re too young to have seen Heathers, what’s going on may feel alien or as if it will soon revert back to “normal.” But if your perspective is broader (i.e., older), you probably recognize this is what the beginning of a bear market looks like.

The last big swing in the market followed the 2008 meltdown. For tech that was only a speedbump, not a tractor-trailer pileup. We need to venture back to the turn of the millennium for a deep, cyclical transition in tech. It’s feeling very 2000: record venture funding, record quit rates, day trading frenzies, a mass tech movement that promises to better humanity. BTW, my favorite movie of 2000 was Magnolia. That same year, I moved to New York to join the faculty of NYU and registered a (paper) wealth decline of 95%. Good times.

Public markets synthesize billions of signals every second and distill these bits and emotions into an indifferent number that points to a direction. Private markets take longer to reflect reality, because private ownership changes hands less often, and out of view. But private markets inevitably come in line, and just like the tail of a whip, the smaller market can deliver greater pain.

Growth hedge funds are registering their worst numbers in years. Earlier this month, Tiger Global announced it was pulling back from funding large, late-stage startups. So did D1 Capital, another growth specialist. Q: Why? A: Simple. They believe there is now better value in the public markets.

Eyes Wide Shut

If you’re under 35, the year 2000 might as well have been the Middle Ages. Which means founder/CEOs are about to add a new phrase to their vocabulary: “down round.”

For two decades, the script, lighting, and backdrop have all centered around one narrative: Grow … at any cost. More raising, hiring, building — the fun parts of running a company. All the while, investors rubbed the smalls of CEO’s backs and channeled their inner Billy Joel: “I love you just the way you are …”

Tales From the Crypt

There’s no way, short of experience, to appreciate how violently things can turn. I’ve been on this ride: It’s nauseating and, though it’s lightning fast, feels as if it will never end … leverage shifts from ideas (founders) to capital (investors). In a bull market, money is everywhere, chasing ideas and founders. When money becomes scarce, its stewards accrete power. Adam Neumann may have been peak founder; super-voting shares and his investors’ fear of losing face gave Mr. Neumann leverage that garnered him a 10% commission on $12 billion in losses. This fulcrum of advantage, like a clock’s pendulum, is rarely in a place of equilibrium. The asymmetric advantage can and will flip to capital.

Power is the medium through which this conflict plays out. Power on the cap table, on the board, to determine the exit and who gets liquidity. Dilution becomes punishing as capital becomes more dear. Companies are forced to raise money at a valuation below that of their prior round: the dreaded “down round.” But they have no choice, because they’re built to burn and need the fuel. So investors take bigger and bigger chunks, while founders’ shares dwindle. In three financing rounds from 1999 to 2002, onerous terms (see above: asymmetric leverage) reduced my ownership in Red Envelope from 30% to 6%.

After years of acting as the doormen, DJs, and dealers at the disco party, VC firms begin scolding CEOs for their profligate spending and demand they sober up. Boards, correctly, ask management to construct a plan that acknowledges the new reality, which is Latin for “fire people.” Over the past three decades, I estimate I’ve hired (personally) 400+ people and fired 100. It’s always awful. It never gets easier.

Founders rarely get fired, but you should expect to see a rise in tweets announcing how thrilled these thirtysomething wunderkinds are to have the wisdom of a new CEO (who the board forced in above them). The share of late-stage startups that are founder-led has been growing, but that will come to an end this year. Prediction: By 2025, the trend in the chart below will be sharply down.

If this is the beginning of a correction, Big Tech will be (wait for it) a winner. For years the narrative has been how difficult it is to hire talent, and how startups with limitless upside are poaching from established players. In 2001, B2C and B2B (as in, business-to-consumer commerce and business-to-business commerce) went from being the two pillars of the dot-com venture-backed boom to being derided as “back to consulting” and “back to banking.” This time, it will be B2BT.

The Walking Dead

A host of illusionist tricks will be deployed to obscure what’s actually happening in the private markets. Deals will be structured so the headline valuation stays high, but the terms — liquidity preference, control mechanisms, and deal structures — will radically change the economics and governance. The next step is euthanasia. Expect to see a lot of unicorns bought for undisclosed amounts. The deals will be presented as strategic, but they’ll really be acqui-hires. The best talent gets new options on more viable equity, the lawyers pick over the patent portfolio, and everything else gets quietly shut down. Peace with honor, sort of.

As you read this, some unfortunate partner at Andreessen Horowitz is pitching a Web3 portfolio firm on a real-time social-audio platform that would be synergistic — and it can be yours for the price of the cash on the balance sheet. The terms of the deal will not be disclosed. We’ll also see a lot of venture firms disappear. Money has been pouring into early-stage investments for years, but as go the private markets, so go VCs. With less money looking for a shepherd, the newcomers and weaker brand names will be unable to raise another fund.

9 to 5

I still shudder at the memory of calling a third of the employees at my first startup into a room and telling them they didn’t have a job any longer. It was horrible, especially because I knew I was the person in the room who’d lost the least that day. But we couldn’t afford them, and if we hadn’t laid them off, we’d have shut the whole business down six months later. Instead, that firm is now a $100+ million business with offices on three continents, employing far more people than we did the day before we fired a third of the team.

Your company is not your family, and your job is not your life. In this growth cycle, the workplace errantly became a platform for your conscience and political beliefs. It isn’t. Your job can be the ink in your pen, but it’s not your story. And despite the Hallmark Channel version of work, where management wraps itself in a progressive blanket and pretends to give a shit about your views on societal issues, don’t bring your whole self to work. This isn’t your family … it’s a team. Do what Jack Grealish did and go where the opportunity is. I have been fired, kicked off boards, had VCs hire Kroll in an attempt to intimidate me, and taken companies through chapter 11 receivership. All of it hurt, a lot. But each setback presented an opportunity, a new perspective, and a chance — even if it wasn’t clear at the time — to allocate my human capital elsewhere at a better return.

Breath of Fire

“Hi, this is Nurse Amanda from Gulfstream School. Your son threw up in class. Poor thing isn’t feeling well — can you come get him?”

Ughhh … I jump in the car, and at school I meet Nurse Amanda and a pale, sweaty 11-year-old. He’s got a minivan strapped to his back and holds a sole-purpose, neon-blue plastic bag. Nurse Amanda recommends he drink plenty of fluids and stay at home tomorrow.

We get in the car, and before I can reassure him he blurts out, “So I started feeling nauseous and went to Mr. Matthew’s desk and … Dad … I began vomiting. So much … it was like the breath of a dragon, and everyone was scared of me. The class began screaming, so I started chasing people as I was vomiting.” There’s real pride in his voice as he walks me through his barf bacchanalia.

Of course, I ask if he caught anybody. He turns serious. “Ethan … He’s slow.”

I had to pull over, I was laughing so hard. Once I caught my breath, I looked over to see my son fixated on me with the type of awe you register when you see something extraordinary for the first time. I don’t laugh out loud a lot. He seemed so happy … that I was so happy.

This Friday we’ll assemble in the school chapel, and they’ll read the names of all the fifth graders who made the head’s list. Last semester my son’s name was on that list. Not this term. But everyone in that chapel will know I am the father of the boy who chased kids down to vomit on them.

I don’t believe it’s possible for him to know how much joy he gives me. What does any of this have to do with the markets melting down? Nothing. But neither does anything really important.

Life is so rich,

P.S. If I’m right — and frankly I hope I’m not — the next five years will introduce early-stage companies to the meaning of the word “crisis.” I cover crisis management in the Brand Strategy Sprint — let’s get to work.

41 comments

  1. MHT says:

    Love the line “Your job can be the ink in your pen, but it’s not your story. ” Great perspective. Happy to be looking forward to what is next.

  2. Kristina says:

    Why is *BIG* Tech going to come out the winner in this correction?

    • Anatoly Geyfman says:

      I think it’s because they’re not relying on inflated valuations to hire and retain people. It will be easier for them to ride out the next few years.

  3. Dom says:

    This should be in every employee handbook!
    “Your company is not your family, and your job is not your life.”

  4. Cam says:

    Thank you for another great post. There is more to life than the job. It is easy to fall into that trap and let your job define your life. The story about Ethan was epic!

  5. Eloise Dawson says:

    nice

  6. Bill Lee says:

    Dear Scott,

    Great perspective on the emerging zeitgeist.

    I’m scratching my head over how puking on another kid, deliberately, is funny.

  7. Gary says:

    You’re very fortunate. Enjoy every moment with your 🐉 🐉!

  8. cliff S says:

    Around when you came to NYY I was starting the EMBA program in Aug ’99. We were begging for DotCom courses. Then after our Tech/Ent. trip to Cali, we were all going to quit our jobs at GE, P&G, and J&J to work at IdeaLab. 9 months later a new DotCom course was established…DotCom crashed…course had no takers…and we all requested an additional course with Damodaran and were happy we did not quit our boring jobs

  9. David Kenny says:

    ❤️This, with the 🔥 of 💯 ☀️, & hoping ‘Part II’ tells us ‘where the opportunity is’, ‘cus we all want to make that Man City move.

  10. Ayo says:

    This has to be one of your best newsletters ever. Thank you, Scott.

  11. Neil says:

    If the sun rises and the sun sets……its been a good day…..

  12. C Cook says:

    Great story, one that many readers will lump with the next Dune movie on the reality scale. But, if you are at a hot startup and have been bragging about it maybe start practicing you humility speech, You will need it. We did in 2001. Next up, review the politics you and your friends have been vomiting out a la Scotts son. Cut the smug self satisfaction of a ‘top’ school and ditch stupid gender crap. It was like Disco, let it die. With that big salary in marketing gone, you will have to live with ordinary razors, cook meals from scratch, and even ‘gasp’ shop in supermarket for yourself. That hot blond may not be so hot for you now that you cannot afford to keep the heat on. Remember, 99% of the world will never have the life you did for a few years, at least you have that. When the cycle returns in 8 or so years, you will be wiser and more importantly humble. For real humility, not the LinkedIN kind. Just don’t be bitter. VCs used you, cute girls used you, and luxury good/image product companies used you. Don’t let them again. Next time, do REAL products. Chips, machine tools, industrial fasteners, something more than building the #3 market leader in organic dog treats. This cycle in done, put a fork in it.

  13. Ron says:

    That was one funny story….trying to distract us from the imminent collapse of the markets brilliant . Life is larger and we must realize the real value that is around us.

  14. Amilcar Alzaga says:

    I generally like a lot your content, I find you very insightful and funny, but from everything I read or heard from you, my favorite part is that paragraph about your sin and how he made you feel. Thank you for sharing that story.

  15. MarcO says:

    The “Breath of Fire” passage made me laugh, cry, and reflect. Thank you.

  16. Carlos says:

    I so enjoy your posts Prof. Galloway. You are a true teacher. BTW, in 2000
    I had just graduated and all I had to my name was debt (to my college and my mom who loaned me some money to get married). 22 years later this downturn actually hurts (which I guess is a sign of some financial success, so I should be happy about the pain?). Thank you for making my day with your son’s story!

  17. Mark says:

    You are a treasure. You and Matt Levine are my favorite columnists in the history of the world, though Alexandra Petri at the WaPo is a close second.

  18. Jon Carson says:

    I sold my EdTech company to Pearson in July 1 2000. I’ll never forget the hair raising stock market swoon expecting a re-price. They held to their agreed price and we crossed the finish line. Which was great because the world turned into a shit show

    One thing not mentioned as part of the movie is VC claw backs. Turns out a lot of firms had been paying out the carry before all the results were in and by 2002 clawbacks by the GPs were in vogue and there were a lot of grumpy VCs scrambling to find the cash. Fun times.

  19. Brian says:

    It’s felt so much like the dot com times again lately. Great post as always. And the Ethan part… amazing.

  20. AJ says:

    As an Aston Villa fan, the Jack Grealish reference still hurts. But I’m happy he’s playing for a champion team (sort of – he still needs time to get used to the Guardiola system).

  21. robert says:

    thank you for making me smile ( and even laugh a little), i don’t know if i totally understood what you were “explaining”? but i’m invested with my limited funds for the long haul, i’m just hoping that things are zipping UPwards when i try to retire in 15 years or so. i’m always looking for tweaks to my portfolio but honestly, i counting on tech and fintech to help me retire with some semblance of comfort. i’m also counting on great things coming out of Isreal tech. sometimes wish i had children of my own to give me the joy so many sincerely express but financially and psychologically i’m prob. better off as an Uncle. thanks again.

  22. Susan says:

    Lol! The best part is hearing about Ethan! That had be hilarious!

  23. Eric Coffin says:

    Ha. Loved the story Scott! When my son was 7, he and one of his classmates decided to climb onto the cubicle walls in the washroom and have, well, a pissing contest. (Ben won). All fun and games intil the principal walked in. Got called into the office so she could tell me he has a three day detention. She was impressed he was totally honest about it and refused to rat out his friends. She tried really hard to keep a straight face as she described the episode. I didn’t even bother trying. Laughed my ass off.

  24. Alan Ivory says:

    Two priceless stories in one email. Talk about value proposition!

  25. Desiree says:

    You never disappoint with your insights. Love it.

  26. David says:

    I have to agree with alot of the sentiment here. I just feel better about life after reading a a Prof G post. Without question Scott’s biggest contribution to a group of people he doesn’t know will be what is important in life. I love reading about his thoughts on business, politics but the biggest impact for me is the re-centering of my life through his articles. I literally think the world is a better place because of this dude.

  27. Joe Buhler says:

    Yes, I do remember 2000 well. Quit my corporate executive job and jumped on the dot com bandwagon myself in the hope of a great exit but the online travel venture folded after 9/11. Also, remember Red Envelope by the way. Might have even used it as an example in Powerpoint presentation!

  28. Dan Hogan says:

    In 2000 I was an an executive on a startup bio-Tec that has raised 35 million and burning $400k a month. Two down rounds
    later and notes at 15% we survived with half of the people. A learning experience.
    Also we have an 11 year old grandson that would be right there with your son. Laughed.

  29. MARC CANTER says:

    There was a time when I thought being on stage with Bill Gates announcing that we were bringing multimedia to the PC – meant something.

    Untill everyone forgot who I was and what I did.

    You’re only as good as your last IPO.

  30. Penelope says:

    OMG! Thank you for sharing your interaction with your son’s incident at school. I actually laughed out loud.

  31. Brian says:

    Ugh – This give anyone else a chilling flashback to that March 20, 2000 Barron’s Article that basically listed the 100 Dot-Com companies that would be bankrupt by Christmas at their current burn rates? Crash was ~2 weeks later. Not that I think about that much.
    https://www.barrons.com/articles/SB953335580704470544

  32. Andre Lee says:

    I shouldn’t be but I’m always surprised to read one or two sentences on this blog that refocuses me on what’s important. This time it’s the fleeting time I have left with the patriachs and matriarchs in my family and the very little time I have left of thinking of my son as a little boy.

    • Amilcar Alzaga says:

      I generally like a lot your content, I find you very insightful and funny, but from everything I read or heard from you, my favorite part is that paragraph about your sin and how he made you feel. Thank you for sharing that story.

  33. Yuri B says:

    When will you finally admit that Biden is a senile, corrupt, incompetent mistake? You take a swipe at Trump who was supposedly so unstable that he would WW3, yet here we are with the “adults” in charge. Do you understand that the woke ESG push into inadequate green energy has weakened Europe to the point where they are dependent on Russian oil? Our entire ruling class should be fired, focus your criticism on them instead of VCs and founders who are actually trying to build and fix things.

    • Pierre Rasputin says:

      You have to admire the speed at which Russian operatives post these days. Extra vodka for you, Yuri!

      • David says:

        The last two Russian invasions happened under Democrat regimes, and none under Trump. Just some facts for you, Pierre.

      • Brandon says:

        Anyone like Yuri who uses logic is a Russian operative. Anyone like Pierre who uses ad hominem smears without a real argument is a good person. Extra social credit points for you, Pierre!

    • OldIndie says:

      Shuttering new oil exploration and voting down pipelines. Biden administration wants US dependent on Russia/MiddleEast oil. As the people of Germany who let their brain dead Green Party shutter nuclear power and put the economy in Putin’s hands. Congrats Greens! Putin is you buddy.