Silicon Valley veteran Keith Rabois: The easy money isn't gone, but the price has increased
After leaving PayPal, he took executive roles at LinkedIn and Square, and also became an investor in many Silicon Valley winners like YouTube (prior to its acquisition by Google), Yammer (which sold to Microsoft), Yelp, AirBnb, and Palantir.
We interviewed Rabois for our feature on what happens now that Silicon Valley has moved out of its latest easy-money boom cycle. Here's a shortened version of our conversation:
Matt Rosoff: What has changed in the last six months? Is the easy money gone?
Keith Rabois: I wouldn't say the easy money's gone, but the price of oxygen has increased.
You may have seen my tweet over the summer, about the steroid era of startups being over ... In the steroid era of baseball, a lot of people were hitting 30 home runs and the perception was that wasn't that difficult, well the reality is almost no one ever hits 30 home runs without using special supplements and the same thing is true-- building a startup to a successful outcome in a major impact on the world is a very very rare thing, and the skills to do that are incredibly rare. And as you deprive companies or take away the steroids, it turns out that very few people can build transformative and disruptive companies that are worth billions of dollars.
Rosoff: Are investors looking for different things now?
Rabois: I think there's a tale of two cities. Most excellent investors are applying roughly the same criteria they've always applied. They have a certain formula that they think predicts success, and they're looking for those ingredients. I do think though that there's a set of investors who are either historically not great investors or are new, and maybe sort of confused by various variables, because there are different ways to assess businesses, especially in the startup days because a company is by definition embryonic.
I think it's much more art than science.
As the new sources of capital or less experienced sources of capital or just inferior investors are stressed and pressured when the markets change, that alternative universe sort of dissipates. So they [startups] feel like everybody's applying different criteria.
Rosoff: What will companies do to bring their burn under control?
Rabois: One of the bigger costs with most of these businesses is people. Compensation of employees. That's a very hard lever to change. At some point perhaps salaries and non-cash compensation go down, but right now that's almost difficult to fathom.
The second big cost is often real estate, office space for all these people. That's subject to a little more short-term market winds, and there's some corrections going on right now in commercial real estate in the Bay Area. But it would have to go down by another 30, 40, 50% to have a meaningful effect on many companies' burns.
The next often lever is customer acquisition and marketing. That one is something many companies can control, but if they have an addiction to growth and they don't have a very rapid payback cycle on their customer acquisition expenditures, then they have a really difficult choice of failing to grow, which makes the business pretty precarious in terms of value, or they need a lot of capital....
One of the key criteria that I always use and we always use is as a fund is payback time. How long does it take to pay back your customer acquisition costs? We're pretty stringent. We really believe that a good business should pay back at 6 months or less. Whereas many people have funded companies that it takes years to pay back. We just don't believe in that. When capital's more expensive nobody's willing to give you the money to invest two years ahead of payback.
Rosoff: So if companies can't get easy capital, they can't control their burn without stopping growing, do they go bust?
Rabois: Some of them have acquisition value, probably not anywhere near their last round price....What companies would be acquired at is probably a fraction of their last round price and that's going to have major implications to the different shareholders.
You haven't seen an avalanche of failures, but I think the percentage will be increasing. If you say there are 100, 150 companies, private, high valuation, a lot of capital, at least half I would say will end in unhappy outcomes. The other half may be spectacular successes....One truly spectacular success does trump a lot of failures. I don't know that it's bad for venture investors, as long as you have a few of those big successes in your portfolio. That said, most investors don't, and can't.
Rosoff: How common are late-stage investors coming in with what Gurley called "dirty" term sheets? Is it a problem?
Rabois: I don't think the terms themselves are problematic as much as many founders not understanding all the implications of those terms.
They basically preclude you from raising private financing in the future. I think that's true, and it's a danger. However, there are some founders who are incredibly sophisticated about this stuff. The right founder with the right asymmetric information about the future prospects of his or her business, it's a gamble that you're going to outperform the valuation. As a general matter, most founders haven't been informed about all the implications.
You're kind of doing a deal with the devil. You want to make sure you understand what hell's like before you make that deal.
Rosoff: What about going public? What does it take to go public today?
Rabois: If Uber wanted to go public, they could go public. I don't know what price they would trade at. There's clearly a demand for their stock. Airbnb, there's infinite demand for Airbnb stock. It's a question of what's the quality bar, how much revenue, what kind of profit margins, how much visibility into future growth must you have?
Rosoff: So why hold out?
Rabois: Because not everybody likes the valuation. I don't think Uber could go public at their last round price, but they certainly could go public at around $25 billion, which by any standard in life is awesome.
If you didn't artificially raise money in the last two years, subject to the valuation, steroids, cheap cost of capital, oxygen kind of points, then you probably could go public with a pretty rational market cap. But if you raised a lot of money in the last 2 years to 3 years, say 2013 to 2015, you'd have this inflated expectation of what the company's worth.
Rosoff: Will big companies come to the rescue with acquisitions?
Rabois: They might acquire these companies at 20 to 70 percent of their prior round prices. A lot of these companies don't have strategic value so there's not that many large acquirers.
Microsoft acquires where it's strategic. Google has retrenched a LOT on acquisitions in the new Alphabet structure, Facebook where something is particularly strategic on Mark's agenda and fits into Mark's vision. Apple's always been a fairly reluctant acquirer.
Rosoff: So what happens next? What do the next couple years look like?
Rabois: It resets the landscape back to normal. There's a natural Silicon Valley ebb and flow, some small percentage of startups succeed, they're transformative, they do change the world. A lot of startups fail. That's part of the business, it's very difficult.
Maybe due to either cheap costs of capital or movies and Hollywood glorification of startups, people perhaps thought somehow it's easy, or more common to succeed. It's not. You're just as likely to be a major league baseball player and bat .300. It's a very rare thing.