Benjamin J Gilbert

There’s been a lot of talk recently, most credibly by Bill Gurley^[1], that we’re in the midst of a bubble that’s due to pop. I won’t speculate on the magnitude of such a decline, but what goes up must come down eventually, and we’ve certainly got a wealth of capital available to startups right now. In this post, I’m going to examine what entrepreneurs can do if and when this happens. But first – an aside on short-selling.

There are many different reasons to short-sell a stock . A recent episode of Planet Money has a very good overview. One that I find particularly interesting is shorting an exchange-traded fund that tracks the entire S&P 500 (SPY)  as a hedge. Let’s imagine this scenario:

1. You want to bet that a specific company will get more valuable over time, so you buy the individual stock.
2. You’re concerned that a drop in the market as a whole could ruin your smart bet on the future of that individual stock.
3. You short the entire market (hopefully with a limit order) so that if the market does drop as a whole, you don’t lose all of your money on that stock you loved so much, even though it wasn’t the fault of that company that they plummeted.

Stock does well? You miss out on some of the gains. Stock market crashes? You aren’t too upset that your favorite stock got dragged along with it.

Now – back to startups. If there’s going to be less capital available, what should we do about it? Can we as entrepreneurs and investors, like the individual public company investor, make a hedge with our time and money to weather the storm? There is no ETF tracking private companies. One way that I can think of is analogous to inferior goods, in the economic sense:

Inferior Good: a good that decreases in demand when consumer income rises (or rises in demand when consumer income decreases) [via Wikipedia]

Startups are the providers of goods or services. If we’re building a business-to-business startup, we can imagine the rest of pre-IPO companies in the world as consumers in the definition above.^[2] After all, with less available sources of capital, their “income” decreases. We can then think about our product offerings this way: what will businesses need when they’ve got less money to play with? I’ve got a few things in mind.

• There is a big opening for low-end disruption in operational expenditures. Companies will be willing to sacrifice the full-fledged functionality of some large software packages for “good enough” ones that are an order of magnitude less expensive (or free with an alternate business model). ^[3]
• There is an opening for products that enable remote work. As employees have more power in the employment relationship, many will not relocate or will want to work from home. Younger companies may wait longer before committing to office space due to the expense as well. If the bubble hits hard enough, people will have to relocate away from expensive city centers, and tools to enable remote work or satellite offices in suburbs will be practical.
• There could be an opportunity to change the hiring model to mitigate “bad hire” risk. Recruiting companies could form a model to take on some of the risk of bringing on an employee in the first few months so a business doesn’t bet the farm on a bad hire.
• With less capital available, investment terms may be less entrepreneur-friendly. Some companies will turn to debt financing, peer-to-peer lending, or crowdfunding to get off the ground. There will be opportunities in providing alternatives to angel and VC money to start a company..

There are surely plenty more, but these are the ones that hit me right away. I generally agree with Paul Graham’s assertion, “Technology progresses more or less independently of the stock market,” but there is plenty of opportunity in applying and combining existing technology to new applications in a market-dependent manner.

In starting companies like these, we’re hedging our bet on the bubble bursting (again, if we’re in one at all). We’re still taking the risk to start a new company, but we’re taking the possible impending decline into account. If companies have less money to spend, what will the side effects be, and who will prosper?

Update: Discussion on Hacker News.

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Notes:

^[1] Sam Altman also makes a great point that we’re all over-hyping this, and we should get back to thinking about what stuff we can build that people want. Hopefully, that’s more of what this post is contributing.

^[2] The businesses directly affected will be startups that require VC and PE funding, but all businesses will feel an indirect effect if there is a bubble burst. Consumers may feel it as well depending on the magnitude, expanding this thesis from merely B2B companies to B2C companies.

^[3] Classically, The Innovator’s Dilemma and low-end disruption theory. Which brings up an interesting question – is low end-disruption likely to occur at a more rapid pace after a bubble pops?

Thanks to David Rosenthal, Jon Fish, Andy Sparks, and Logan Frederick for reading drafts of this.