Sequoia helps start-ups cut costs or face a ‘death spiral’

One of Silicon Valley’s most successful venture capitalists doesn’t see the economy rebounding anytime soon and is warning its portfolio companies to tighten their belts in the meantime.

In a 52-page presentation seen by CNBC, Sequoia lays out a litany of risks making it harder for founders to raise funds and operate. The memo, first reported by The Information, was released last Monday by Sequoia partners Alfred Lin, Roelof Botha, Doug Leone and Carl Eschenbach, and others.

“We think this is a Crucible moment,” reads the presentation. “First and foremost, we need to recognize the changing environment and shift our mindset to respond with intention rather than regret.”

Sequoia, known for its early investments in Apple, Google and Airbnb, sounded the alarm before other crises. The company issued a memo titled “RIP Good Times” as the economy slumped in 2008, and a widely read “Black Swan” memo at the start of the coronavirus pandemic.

In the most recent, Sequoia points to sustained inflation and geopolitical strife limiting the possibility of a “quick political fix” such as interest rate cuts or quantitative easing.

Sequoia’s partners said they got one factor wrong in the latest memo: underestimating the monetary and fiscal policy response that followed the covid crisis, “and the distortion field that created” on the steps.

“This time around, a lot of those tools have been exhausted,” the presentation said. “We don’t think this will be another steep correction followed by an equally rapid V-shaped recovery as we saw at the start of the pandemic.”

Sequoia joins a chorus of venture capitalists and investors on Twitter warning founders of the current macro environment.

As Lightspeed put it in a blog post last week, “The boom times of the past decade are unambiguously over.”

Tech companies that have seen phenomenal growth during the pandemic are already taking steps to cut costs by cutting jobs or freezing hiring. Klarna said this week that it plans to lay off around 10% of its global workforce, following similar announcements from Robinhood and Netflix. Meta, Uber and Nvidia, Facebook’s parent company, are also among the companies slowing hiring.

Sequoia sees this as a potential silver lining for recruiting, as “all FANGs have hiring freezes.” The company urged its founders to review projects, research and development, marketing and other expenses to be prepared to cut costs and avoid a “death spiral”.

“Companies that move the fastest have the most leads and are most likely to avoid the death spiral,” the memo reads. “Look at this as an incredible opportunity. You play your cards right and you will come out of this as a strong entity.”

Forget “growth at all costs”

Stock markets have been rocked in recent months by inflation fears, the war in Ukraine, supply chain issues and the Fed’s decision to raise interest rates. Sequoia reports that the Nasdaq recorded its third largest decline in twenty years and that many high-growth stocks lost two years of price appreciation. For example, 61% of all software, internet and fintech companies are trading below pre-pandemic prices.

“The era of reward for hypergrowth at all costs is rapidly coming to an end,” the Sequoia memo says, noting that software revenue multiples have halved in the past six months and are trading below of the 10-year average. “It may not translate overnight to your valuation, but over the medium to long term, disciplined and sustainable growth is always rewarded and results in significant appreciation in value.”

On top of all this, they warn that “cheap capital” does not come to the rescue. Crossover hedge funds, which have tapped into private markets and venture capital investment in recent years, are “nursing their wounds in hard-hit public portfolios,” the company said.

Still, Sequoia points to an opportunity for resilient founders. Partners cite Cisco after the 1981 crash, Google and PayPal surviving the dot-com breakup, Airbnb emerging from the financial crisis, and DoorDash navigating the pandemic. The winners, they said, are those willing to confront challenges that “may have been masked in the exuberance and distortions of free capital over the past two years.”

Michelle Bailhe, a partner on Sequoia’s growth team, told CNBC that the appropriate amount of cost reduction for each company depends on activity and cash burn, and not everything will result in a freeze on hires. In some cases, it is better to “keep your foot on the accelerator in your core business because you can come out of it even stronger”.

“The message we wanted to get across to founders was that for the best companies, this should be your time to shine, because when it’s easy for everyone to fundraise and get demand, you don’t see so much the strength of some of the distinctive elements companies and teams,” Bailhe told CNBC’s Crypto World on Wednesday. “The playing field has become more difficult, which would benefit the types of people who take advantage of this opportunity the most.”

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