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Startup Investing During Shaky Financial Times

Startup Investing During Shaky Financial Times
By Adam Sharp
Date October 8, 2019

As you probably know by now, I believe the world is headed into some… interesting financial times.

Here’s how I described the problem in a recent Early Investing article about gold:

Governments, people and businesses around the world have big piles of unpayable debt. And, unfortunately, most of the borrowed money isn’t being spent productively.

We’ve reached the stage where countries and companies are borrowing at an accelerated rate just to pay the interest on their debt…

It’s pretty obvious to me how the powers that be are going to handle this mess. They’ll use Modern Monetary Theory, debt monetization, currency devaluations, a debt jubilee or some other crazy scheme to try and get out of trouble. Let’s simplify things and just refer to it as “printing money.”

Basically, I think the U.S., and much of the rest of the world, is likely to experience stagflation in the near future. If you’re not familiar with the term, stagflation means high inflation and low growth.

If I’m right, what does this mean for startup investments? For one thing, it means opportunities will abound. Most corporate giants today have too much debt, use bad software and pay their CEOs far too generously. There are dozens of giant “zombie corporations” that are surviving only because of the Fed’s low interest rates.

If we do go through an economic rough patch, a lot of these dinosaur-esque companies will fail. Holes will open up in industries worldwide.

And then lean, efficient, software-enabled startups will have all the opportunity they could ever ask for. This applies across most industries.

Look for Lean, Bootstrapped Startups

A downturn will still affect startups – but it’s not necessarily bad news. New average valuations would drop (which is good for investors). Funding may become hard to find at some point (although this would likely be at least two years off, since billions of dollars in new capital has been raised over the past year).

This means I am personally putting more emphasis on finding lean, preferably bootstrapped, startups. A bootstrapped startup is one where founders didn’t raise much, if any, outside money in the early years. Ideally, the founders funded the first few years themselves. These types of deals are always worthy of extra attention – but especially so in this environment.

If a startup successfully bootstrapped its first few years and managed to grow into something substantial, it’s my absolute favorite signal. It means the founders know how to spend money efficiently. And they’re powering the business with sweat equity.

In the aftermath of the WeWork debacle, this is more important than ever. I have a feeling this was an “aha” moment for Silicon Valley. Much more emphasis will be placed on sustainable business practices going forward.

Great Bootstrapped Deals Are Rare

It’s important to realize that you won’t be able to invest only in great bootstrapped startups. These kinds of deals don’t come along too often. Out of the thousands of deals I’ve examined, I’ve probably seen only 12 really promising ones (and I invested in the majority of them).

But you can always find startups that are operating in a sustainable way and not burning too much money every month. If the startup is burning a lot of money, you need to make sure it has the backing of a strong lead investor.

Of my two unicorns so far, one was a bootstrapped story (FabFitFun) and one was a “spender” (Cabify). By spender, I mean it wasn’t bootstrapped and was spending a lot of money. I was comfortable backing Cabify because it had incredible growth and access to capital (it already had great angels and venture capitalists, or VCs, involved).

And to be clear, I’m not saying you should pass on spender startups. If they have the backing of serious angels and/or VCs, they’re certainly worth a look. The best startups will be able to raise money in any environment. Just make sure the opportunities you invest in have serious traction or revenue to back up the spending.

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