Sequoia asks founder ecosystem to tighten belt, focus on profitability

Cash burn and growth at all cost no longer being rewarded as capital turns expensive

Burning cash to capture growth may have been the mantra at several startups, but with capital becoming expensive, Sequoia Capital is telling its founders to focus on profitability. Sequoia Capital India has invested in almost 30 unicorns of the 100 that India has.

“We are just beginning to see how the increasing cost of money flows through to impact the real economy. If you’re stepping back and thinking twice, it’s not just you. Belt tightening and priority reassessment will have second- and third-order effects, as one company’s costs represent someone else’s revenue or purchasing power,” said the VC fund in a 52 page presentation to its founder community.

Business Standard reached out to several Sequoia Capital India funded company to check the mood after the presentation, while a few did not comment, one of the startups founder on condition of anonymity said, "This is a general trend we have been hearing. Investors are being cautious. We have had some of the other investors also reaching out more aggressively now."

The presentation stated, “We are witnessing the third largest Nasdaq drawdown in 20 years. The Nasdaq is down 28 per cent since last November. At a high level, the market isn’t as challenged as it was in during the .com crash or the global financial crisis, but the story underneath the surface is more revealing when you look beyond the mega caps,” said the company.

About 61 per cent of all software, internet and fintech firms are trading below pre-pandemic 2020 prices.  Non mega cap stocks are down meaningfully more than the Nasdaq. They’ve lost more than two years of stock price appreciation, despite many of these firms more than doubling both revenue and profitability, the presentation said.

“The era of being rewarded for hypergrowth at any costs is quickly coming to an end. EV / Revenue multiples across software have been cut in half over the last 6 months and now trade below the 10-year average. With the macro uncertainty around inflation, interest rates, and war, investors are looking for companies that can produce near-term certainty. Capital is becoming more expensive while the macro is becoming less certain, leading to investors de-prioritizing and paying up less for growth,” said Sequoia Capital.

The presentation further noted that one-third of these companies not only trade below their pre-pandemic stock prices, but they are now trading below the bottoms reached during March 2020 at the height of fear of the Covid-19 pandemic. The market is now pricing in lower values for many stocks than in March 2020 at a time of peak uncertainty.

Hence the big focus now is profitability. “While the Nasdaq is down, Morgan Stanley’s unprofitable tech index is down 64%.  With the cost of capital (both debt and equity) rising, the market is signaling a strong preference for companies who can generate cash today,” said the presentation.

The worst this time is unlike earlier periods, sources of cheap capital are not coming to save the day. “Crossover hedge funds, which have been very active in private investing over the last few years and have been one of the lowest cost sources of capital, are tending to wounds in their public portfolios which have been hit hard. Many don’t even have the capacity to invest, as the drawdown in their public portfolios has created an imbalance in their hybrid funds where their private investments (which have not been as dramatically marked down) represent more than the maximum private capacity within their funds,” said the VC fund.

The investment firm asked its founders to focus on durable growth. “These are tough markets to navigate. It’s not just valuation but also real economy risk with a weakening consumer that is weaning itself off fiscal stimulus while simultaneously dealing with rising inflation. But, what works in any market, is consistent growth and disciplined financial management that translates into improving margins.”

The fund asked founders not to panic but pause and reassess. “We believe this is a Crucible Moment, one that will present challenges and opportunities for many of you. First and foremost, we must recognize the changing environment and shift our mindset to respond with intention rather than regret,” said Sequoia Capital.

Those who adapt and pivot are the once who will survive. “It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change. Companies who move the quickest have the most runway and are most likely to avoid the death spiral. Do the cut exercise (projects, R&D, marketing, other expenses). It doesn’t mean you have to pull the trigger, but that you are ready to do it in the next 30 days if needed,” shared Sequoia Capital.

Sequoia’s letter to the founder comes at a time when several VCs and investors have hinted to tightening the belt. The impact is already visible with layoffs happening across the Indian startup ecosystem.

Last week, Silicon Valley Y Combinator also warned its portfolio firms about the changing dynamics and worsening of the macro.

The points highlighted by Sequoia Capital are applicable to the Indian startup ecosystem as well which has seen several of the big IPOs current share prices much below the listing price.

Masayoshi Son, founder and chief executive officer of SoftBank, in its recent investor call said the firm may invest only half or a quarter of what it did last year. Son’s comment signals a slowdown in large funding rounds globally and in India. SoftBank reported an annual net loss of $13.12 billion.

“Nobody knows what will happen tomorrow in this kind of market. We have to prepare for the worst. I want to put ourselves into defence mode and pile up lots of cash in hand. We would be much more careful when we invest new money,” said Son, in a company webcast.

‘Prepare your company’

• Cash and cash flow
• Create financial degrees of freedom
• Earn most from customers
• Improve your unit economics
• Cut expenses, should have done that
• If necessary; raise equity or debt, even if it’s expensive