Coronavirus Forces Tech Startup Founders to Grow Up Fast

The motto for Silicon Valley startups was often “Move fast and break things.” Now it’s “Cut fast and cut deep.”

Francis Davidson’s biggest challenge last year at his short-term apartment-rental website, Sonder Inc., was fending off a dozen new rivals fueled by a flood of investor capital. It wasn’t the worst problem a 27-year-old could have, as he ran a startup valued at $1 billion.

Today, the economic impact of coronavirus has cut April sales by at least half, while fixed costs remain. His job is negotiating lease concessions, refusing refund requests and axing a third of his staff. One of the hardest tasks was letting go a recruiter who last year lost his infant son.

“This is the most insane thing I’ve faced in my career,” Mr. Davidson said. “I started this company when I was 19. I’ve never seen a recession.”

CEO

Sonder CEO Francis Davidson at a company forum in San Diego in March 2019



Photo:

Peter Grigsby

The coronavirus crash is a profound jolt for startup founders accustomed to a sea of cash from venture capitalists floating their entrepreneurial dreams. Investors have thrown money at all kinds of startups in recent years, stretching into categories well beyond technology, from real estate to meal prep to mattresses. Inexpensive money, fueled by a decade of low interest rates, paid the tab.

Conquering founders were still following a go-big-or-go-home approach—blitzscaling, as some called it—when the pandemic arrived. After years of blowing through cash, they have to grow up fast and must make tough decisions to conserve it.

That is bad news for the more than two million people employed by venture-capital-backed private companies in the U.S., as tallied by research firm Pitchbook. And that figure doesn’t count millions of gig economy workers attached to large tech companies such as

Uber Technologies Inc.,

who won’t be able to make up the lost work despite a boomlet in grocery and package delivery.

The pullback could be temporary. Deep as the economic contraction is, it’s possible the huge monetary and fiscal stimulus it unleashed could set up another boom once the virus threat fades and the world goes back to work. If

Amazon

deliveries and Zoom video conferencing are any indicator, technology may be more central to our post-pandemic lives than ever. Tech startups that survive would be poised to ride the next wave.

For many, getting to the other side means cutting payroll, slashing marketing budgets to $0, eliminating perks, asking vendors to extend payment terms and scratching for additional capital.

About 250 U.S. startups laid off a total of nearly 25,000 workers, according to layoffs.fyi, a website that has sprung up to track the carnage but can’t capture all of them.

A fleet of more than 7,000 drivers for HopSkipDrive Inc., which ferries kids to school and activities, sits mostly idle. HopSkipDrive works with thousands of schools in 13 metropolitan areas. Founder Joanna McFarland says she knew her business was in trouble on March 12 when Seattle-area schools set a six-week closing.

chief executive

Carter Tartisel, 10, selected his music on driver Jacqueline Bouknight’s phone while getting to his math tutoring in Alexandra, Va., via HopSkipDrive in April last year.



Photo:

April Greer for The Wall Street Journal

“That was the moment I realized every district would close,” she said.

She pivoted to damage control, Ms. McFarland said, because as a young investment analyst during 9/11, she had seen how companies that made quick cuts emerged stronger. She fired about 15% of her corporate employees and eliminated all advertising. She put expansion plans on ice.

The belief among startup founders in recent years was “if you throw enough capital at it, you eventually figure it out,” said Ms. McFarland, who is 43. “When you have an overabundance of capital, you don’t have to prioritize as ruthlessly. They have to make really hard decisions right now.”

Cockroach Labs Inc.

Joanna McFarland founded HopSkipDrive, which ferries kids to school and activities in 13 metro areas. She knew her business was in trouble when Seattle-area schools decided to set a closing.



Photo:

Allison Zaucha for The Wall Street Journal

Last year, investors poured $136 billion into U.S. startups, according to Pitchbook, just short of 2018’s record $141 billion. For some entrepreneurs, discipline disappeared. Pliant investors and unlimited capital removed pressure to operate profitably.

Rising Tide

U.S. venture capital investment soared in recent years.

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Lyric Hospitality Inc.

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The ready money also allowed startups to remain private longer, avoiding the scrutiny of public markets.

A shift began last year, as a few large private companies such as Uber,

Lyft Inc.

and WeWork owner We Co. discovered that investors wouldn’t tolerate unending losses. Still, most startups kept the focus on growth.

With the hammering from Covid-19, including stay-at-home orders in many states, some founders find sales haven’t just plummeted, they’ve stopped. Investors have pulled back offers or changed the terms. Those still willing to finance startups have gained significant negotiating leverage overnight. Airbnb has borrowed $2 billion in recent weeks at a blended interest rate of close to 10%. Some of those lenders have the right to buy equity at a 40% discount to its valuation three years ago.

Bhavuk Kaul, co-founder and chief executive of Plate IQ, a provider of restaurant software, signed a letter of intent in January with K1 Investment Management in Los Angeles for $15 million of funding. He was riding high that month. His San Francisco-based startup had more than doubled its revenue in a year, and four investors wanted to pour in capital.

Rolfe Winkler

Bhavuk Kaul of restaurant software provider Plate IQ with his dog, Kaizer, in San Francisco.



Photo:

Cayce Clifford for The Wall Street Journal

The letter of intent he signed with K1 required him to spurn the three other investors and targeted a speedy close, according to a copy reviewed by The Wall Street Journal.

On March 17, the day after San Francisco residents were ordered to stay home, and as restaurant traffic suffered a breathless fall, Mr. Kaul said a K1 executive called to say the financing was off.

Mr. Kaul, 44, said Plate IQ had run up a six-figure legal bill to close the deal. The K1 executive said he hoped to work with Plate IQ in the future. Mr. Kaul told him he never wanted to work with K1 again.

A spokesman for K1 said it decided not to pursue the investment because of “extraordinary changes in circumstances.”

Privacy Protected

Fewer companies are going public and those that do wait longer.

Spencer Kimball

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via newsapi.org

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Wall Street executive

Venture-capital backed IPOs

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$300

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Data on startup financing is compiled slowly, so it’s too soon to see the pandemic’s impact in statistics. While venture capitalists make a show on

Twitter

of being open for business, founders say they are making far fewer new investments, while focusing on how to help existing portfolio companies.

Some entrepreneurs wish they’d taken rich deals that were on the table.

Cockroach Labs Inc., a database company, was offered funding earlier this year that would value the private company at $1 billion, a jump from the $550 million valuation in its last financing, said people familiar with the offer. Spencer Kimball, its 46-year-old chief executive and co-founder, didn’t jump on the offer right away because he hoped a better deal might come along, these people said.

In an interview, Mr. Kimball said he wasn’t trying to get a better offer. He said he waited partly because he wanted to recruit another outside investor to help the company ahead of a future initial public offering. Also, he said, he hoped to recruit top-flight engineers, tempting them with stock options that would instantly leap in value after a new equity financing round was sealed.

When the market tanked, the funding offer, which came from investment firm Altimeter Capital of Menlo Park, Calif., was gone. The two agreed to a new deal last week at a valuation above $800 million, according to Mr. Kimball. He said he wanted to get cash in the door to weather the storm.

“In hindsight, of course, I wish we had locked that in,” he said of the first offer. “I just went through a process that was very nerve-racking. It would have been nice to just focus on the business. But I think we’re in a good place.”

Altimeter Chief Executive Brad Gerstner declined to comment on the Cockroach Labs deal. He said economic uncertainty is driving down prices and his firm will continue doing deals.

chief executive

Andrew Kitchell, Lyric Hospitality co-founder & CEO.



Photo:

Lyric

When Andrew Kitchell set out in late 2018 to raise capital for Lyric Hospitality Inc., a Sonder rival in short-term apartment rentals, he was looking for $30 million. At the time,

SoftBank Group Corp.

’s $100 billion Vision Fund was throwing cash at companies and telling them to grow even faster than their already-ambitious plans. “It was an incredible atmosphere to raise capital in,” said Mr. Kitchell.

Lyric’s funders didn’t include the Vision Fund, but its effect on the financing market helped Lyric raise three times as much equity capital as it had targeted and five times as much debt.

Lyric’s sole goal was adding short-term-rental listings to its website as fast as possible, said Mr. Kitchell, its 36-year-old co-founder and chief executive. “The pendulum was 100% on growth. Don’t worry about [profits], they will come” was the message in the boardroom, he said.

Lyric and competing startups followed a strategy similar to WeWork’s—piling into long-term leases on properties to lock up space they could rent to customers. It was a quick way to grow.

Mr. Kitchell began to think about long-term leases differently last summer, he said, when a Wall Street executive warned him of the danger in lease liabilities. “You and other people in Silicon Valley aren’t thinking about it like debt. And you need to, because the music is going to stop,” he says the executive told him.

WeWork’s botched IPO a few weeks later pushed Lyric to sign less risky deals, but most of its properties were still leased long term. Many now sit empty as the virus prompts travelers who rent such apartments to stay home.

“The tide went out. A lot of us were swimming for shore and going to make it, but then this happened,” Mr. Kitchell said. “Time to cut back, let the storm pass, and then build again the right way.”

On March 20 he told much of his workforce they would be let go in two, four, or six months, staggering the pattern to give some time to find other jobs. He offered full refunds to customers who canceled.

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Are tech startups right to pull back and conserve cash or should they charge ahead focusing on growth? Join the conversation below.

Sonder’s Mr. Davidson faced the same hard choices, and quickly cut the trappings of Silicon Valley life. Gone were the free lunch for employees and the $10 per diem if they wanted to eat elsewhere. Out went the cereal and snacks and fresh fruit, and the $50 per employee per month budget for team-building activities.

These were easy cuts, since employees were sent home to work, Mr. Davidson admits, but he hopes the thrift persists after the pandemic. He said he has cut his own salary to $0.

“Frankly, it’s a bit ridiculous how pampered employees in [Silicon Valley] are,” but the glut of capital made it necessary, he said. With a Vision Fund-backed rival, Oyo Hotel and Homes, moving onto Sonder’s turf last year, Mr. Davidson felt his firm had to provide nice perks to compete for talent. Oyo recently furloughed workers after its CEO said sales fell 50% to 60%.

On March 3, two weeks before virus containment shut swaths of the economy, Mr. Davidson huddled with Sonder executives who wanted to soften the company’s refund rules.

Sitting at the head of his conference-room table, in a chair covered with blue shag carpet, Mr. Davidson pointed to Covid-19 data from Italy. Never mind customer blowback—Sonder’s survival was at stake.

The onetime consensus-builder vetoed his team. Sonder needed to conserve cash, and it would stick with its tough policy on cancellations. His call saved Sonder at least $8 million, he estimates.

Mr. Davidson’s biggest albatross is leases. He has negotiated more than $20 million in concessions and hopes for more. He said the company has signed a term sheet to raise more money from investors but declined to disclose the terms.

“Our strategy is make it through,” Mr. Davidson said.

He added: “I think I will be served well with paranoia.”

Write to Rolfe Winkler at [email protected]

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