Do you remember the mortgage crisis? In case you didn’t hear about it — or don’t remember the details — it worked something like this:
- Banks figured out a new way to profit from mortgage loans, even if the loans never got paid back…
- …which led them to loan money to people who’d never be able to pay the loans back, because they got paid either way.
- High demand (thanks to easy money) drove home prices up, up, up.
- The economy boomed.
Years passed.
Then results of this disruptive innovation became clear:
- People defaulted on loans they could not afford;
- Demand dried up;
- Home values plummeted, causing more and more people to default;
- Homeowners stopped buying things related to homes — due to the exuberant valuations drying up…
- And, as things worsened, their total spending on other things contracted too, as they found themselves in an untenable financial position;
- Industries founded on home-related spending faltered;
- People employed in those industries lost their jobs;
- Those people lost their spending power, and other industries fell victim, too.
Bam. Financial crisis.
This is a simplification — there was more to it — but there was not less to it. These things are true. This is what happened.
The mortgage industry disrupted home ownership. It innovated on its business model. It created explosive growth engines.
Then it went kaboom! and took large parts of the economy with it.
People who took out loans they did not “earn” suffered. People who relied on those people’s participation in the economy suffered. Eventually, just about everyone who participates in the economy suffered.
Everything tightened up and constricted and sucked.
It’s going to happen again, soon — but on a smaller scale. And it’s going to happen to us.
A few simple economic truths
Truth #1: Easy money is toxic to economic systems.
Truth #2: Systems which decouple rewards from performance are toxic, because they create easy money.
Truth #3: When rewards are decoupled from performance, and the bill only comes due after 5-10 years, economic systems will appear inevitable… right up to the point where they implode, and everyone is cut to pieces by the shrapnel.
That brings us to startups.
How venture capital works
Venture funds are made up mostly of money from large institutions.
Those institutions could invest in many different investment vehicles. One of them is venture capital — due to an expectation of outsized rewards.
Funds are administered by venture capitalists. They decide who gets investment in their company.
(And venture capitalists are largely paid from management fees, regardless of performance.)
Venture capital investments in startups take 5-10 years to mature, which is to say to realize a return…or to confirm that they will give no return at all.
Oh, and when returns do happen? Most of it it comes from successfully gaming an expectations market — not, in other words, based on normal economic trade, e.g. “Will this startup be able to sell $1,000,000 of widgets in 2014?” but rather how institutional investors and acquirers rate other investors’ and other acquirers’ expectation of the startups’ potential. “Will the stock market really like their stock?” or “Will Google just have to have them, because their user base is so large otherwise someone else will buy them?”
In other words, easy money rewarding easy money.
That’s why startup winter is coming.
The venture capital industry at this point seems inevitable. All the ingredients are there: easy money, inflated values (both for startups and the things they spend that money on), entire industries built up to serve the apparent economic boom.
But we’re coming up fast to the end of the beginning of the most recent investment wave — the investments made in 2004 to 2009 are supposed to be maturing right about now.
And realizing a return — or not
Results are in…venture capital returns aren’t great. The first reports were dismissed by many. More reports are coming in.
And hey, the venture capitalists get paid, either way.
But as the (lack of) returns becomes clear, the institutional investors will seek other, better places to put their money.
Brace yourselves.
Everyone who has lived off the easy money is going to suffer.
Startups seeking venture capital will see the first wave of pain. These are equivalent to the folks who went into default, or the folks who tried to get a loan just a little too late.
Then the people employed by these startups will be hit next, salaries dropping like home prices as buyers dry up.
Then the services that these startups — and their employees — rely on.
And their employees.
Save yourselves.
If you rely on venture capital to do what you do, time to get serious. Seek profit. Seek sustainability. When the available funding dries up, your options will be decreased. More startups will find themselves on the brink of destruction… and acquirers will get some great deals.
If you rely on a salary inflated by easy money — by imaginary, unrealized value —then my advice is two-fold: First, sock away as much of that money as you can. Second, take the time & invest the effort into learning how your skills can produce economic results for your employer (now, or in the future).
Easy money overspends. Easy money doesn’t ask itself, “Is this worth what I’m paying for it? Will I get back more than I spend?”. Everything seems more important than profit. But when easy money dries up, ROI becomes the only question.
If you can show you can produce serious economic impact for your employer — for any employer — you’ll be in a position to survive and thrive when the easy money’s gone.
Finally, if your business sells (directly or indirectly) to startups, it’s time to diversify your customer base. Or else, what will you do when economic reality cuts through them in huge swathes? Now is the time to serve & deliver value to industries that are less prone to boom and bust, who fund their purchases with income and not investment.
If you don’t heed the signs, you might still survive. But then it becomes a question of luck: Where will you be when the air goes out of the room?
If you pay attention, and prepare now, you can be ready.
This is why I do what I do.
I could make more doing things differently, engaging in the system as I’ve described it… but I remember the first bubble, and I’ve seen the corrupting power of easy money on the places I’ve worked.
When value — aka real returns — is taken out of the equation, the entire economic system is weakened. The problems start on the small scale, inside individual companies. But they extend everywhere.
High returns disappear when you average them with what comes afterwards.
No doubt, easy money is tempting. That’s why it’s so dangerous.
Earning your money through value may be “the hard way,” but it’s also the way that will endure.
Bootstrapping is the logical approach.
Bootstrapping, the way we teach it, requires that you deliver measurable value to customers who care about value — and pay for it. You help them create value in their businesses, and they pay you your share of it.
Yes, you certainly could bootstrap a company totally reliant on easy money — like starting an overpriced home remodeling company in the housing boom. But that’s a choice, not fate.
When you create (or work for) a startup that can’t survive without infusions of venture capital, you give away all your choices. Your fate is sealed.
Bootstrapping creates choices. And the freedom to learn how to make better ones.
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