The vaccines are coming; now what?

The arrival of several highly efficacious vaccines – whose rapid advent is itself a modern technological marvel – allows us to finally ask with more temporal certainty, “what’s next?” and “what’s next for tech?” While at the same time we hunker down and take precautions for what may yet be the most painful and dangerous months of the pandemic, we may now hopefully look to mid-2021 when a semblance of normalcy for our lives and all sectors of the economy is likely to return.

Just as we planned and adjusted when COVID hit, it’s time to do it again. Naturally the exercise is largely dependent on how a startup was initially affected by COVID and whether those trends will have inertia or fully abate. However, every startup needs to consider implications to cash and the longevity and viability of remote working in a less contagious world:

The few companies that benefited from COVID have to make bets on behavioral inertia.

Whether a D2C e-commerce brand or a telemedicine startup, each startup that benefited from COVID is asking the question, “how long will this last?”. In many cases, we expect modified behaviors to have permanence. It’s reasonable to believe that many consumers who recently crossed the abyss to online grocery ordering may want to remain there much of the time, or that remote employees will want to keep working from their new pied-a-terre in the country. In fact, many of these changes have taken structural form, including the flight to the suburbs and office down-sizing. Purchased homes and new leases have permanence. We also know that it won’t all stick. Zoom stock is down 27% from its peak a month ago as the light at the end of the pandemic tunnel emerges. While there is no single expectation that fits, VC Fred Wilson suggests that a 50% reduction in excess demand caused by a shock is a reasonable place to start in planning for the aftermath. If companies can flex that assumption in their model up to 75% and down to 25% while still achieving solid growth and efficient burn, that is a robust plan.

Not yet party time for everyone else

So for the companies that were deeply impacted by COVID or for those that were relatively unaffected, is 2021 going to be a party? Not likely. For example, the travel industry may take years to return to pre-pandemic levels. Some of this will be a result of lingering contagion or fear and some the result of entrenched behavior change. Even less affected industries are not likely to see a rapid jump back to pre-pandemic levels as demand and job recovery always take time. The exception may be in consumer goods and experiences, where an unprecedented increase in consumer savings rate over the last six months may portend a release of spending in 2021 when confidence and job prospects improve.  We are encouraging our most heavily affected companies to take it slow in 2021 and allow each increase in spend to prove itself with commensurate demand before taking on more expense.

Cash is still king

While venture capital didn’t experience the apocalyptic decline some predicted – and in fact had a banner third quarter this year – much of that favored a few late stage winners or COVID standouts. Moreover, the standards and milestones of success have not loosened because of COVID. Startups are still expected to at least double year-over-year to be fundable through Series B. That was uniquely difficult in 2020 and will remain so in 2021. Without a free pass on a bad year, most companies that limped through 2020 will have to preserve cash through 2021 as they slowly claw back towards growth. This will be very hard for most, and there may yet be casualties.

Remote people and culture are here to stay

By 2025, it may be that the most permanent vestige of the pandemic at startups is remote teams and culture. Before COVID, about 10 to 15% of companies we saw had majority remote teams. With that number now near 90%, we think it will settle in the 50 to 60% range in a few years. The barriers to productivity have largely fallen as we’ve all learned to work remotely, and the benefits of being able to hire anywhere, including on a contract basis, can make a startup more nimble. As a geographic focused investor, we’ve thought a lot about what that means for us. While we still believe our geographic focus brings network effects in our ability to find and help startups, we expect more of our investments to have a considerable remote workforce, albeit with a mid-content HQ. You have to host the holiday party somewhere!

While it is a relief to look ahead to a brighter 2021, we know that the next few months will be difficult for all, directly painful for many and tragic for some.  Let us all be safe and good to each other as we transit this last leg.

That new CARR smell

With politics and the pandemic hurtling towards a crescendo this week, I thought it would be a welcome distraction to talk about something equally as controversial… Contracted Annual Recurring Revenue (CARR). (The comparison is mostly a dark joke, so spare me any indignation.)

We started seeing CARR enter the startup lingo about five years ago, but typically only inside of enterprise software startups in their tracking of implemented revenue versus signed revenue. Then CARR started appearing in investor decks, then companies wanted to be valued as a multiple of it instead of ARR, then companies started talking about “verbal” Contracted Annual Recurring Revenue (VCARR). Oh boy.

Here is how we think about ARR and CARR and how they relate to each other:

Your current GAAP (recognized) monthly revenue x 12, excluding any transactional revenue

= ARR (very conservative)

+ transactional revenue that is highly certain to recur (example would be “metered” subscription models like say charging $1 per truck load in shipping)

= ARR (nominal)

+ additions to ARR expected in the next 6-12 months (or maybe before end of calendar year) that represent increases baked into contracts that are already implemented. This could include highly likely increases to recurring transactional revenue for certain models

= ARR (liberal)

+ “ARR” that is contracted but not yet implemented or billing, representing what will be billing immediately after it is implemented

= CARR (nominal)

+ increases to CARR that represent contracted annual price increases over time in contracts not yet implemented, including future “recurring transactional” revenue

= CARR (liberal)

+ contracts you think you have a verbal on

= VCARR (bullshit) = bullshit

We generally prefer the use of ARR (nominal) and CARR (nominal) both in working with our companies and in evaluating new investment opportunities. We prefer these versions because their constituent parts are more transparent and objective. The difference between them is also very clear. ARR is monthly revenue today x 12, and CARR is monthly revenue if we finished all implementations today and multiplied by 12. We loathe VCARR.

But don’t you want to take credit with your BoD or an acquirer/funder for everything you have signed? Of course, but if there are too many assumptions in the underlying structure of a metric, its veracity collapses, potentially requiring backtracking, reforecasting or undermining your story with a BoD or acquirer/funder. Using nominal definitions, it is okay to say our ARR is X today, but in six months, we already have Y baked in, representing contracted increases. Similarly, many companies will talk about TCV, which includes the value of multi-year contracts.

These days, we are seeing most companies valued by some multiple of ARR (nominal) or expected year end ARR (nominal). If the former, credit is usually given also for unimplemented contracts (CARR – ARR). If the company is later stage with a long history of successfully implementing contracts, there may be no discount on the multiplier used for the unimplemented contracts. For an early stage company say with $1M in ARR and $1M in unimplemented contracts (CARR = $2M), the discount on the unimplemented multiplier might be as high as 50%, given more uncertainty about implementation success.

What matters the most is that whatever metric you choose, it is clearly defined, transparent and able to be objectively measured. Otherwise your new CARR will smell fishy.

Apocalypse Later

In March the consensus among venture investors – especially ones who had witnessed the .com boom, financial crisis, or both – was that dark times were ahead. Sequoia and others quickly warned their portfolios to significantly cut expenses in expectation that demand would disappear, in most cases regardless of industry or business model type. We did too. 

Now almost six months later, the new narrative is that things didn’t turn out as badly as we thought. As evidence, startup financings remained relatively robust in Q2 and into Q3, there has not been a second wave of tech layoffs (and hiring has even restarted) and most companies are seeing a return of demand, albeit often at a muted level.

So did everyone overreact in March? I don’t think so. On the one hand, returning demand is a great thing, on the other hand, there are signs of a structural disequilibrium between main street, public stocks and the startup/venture market. There is also a foreboding sense of complacency with truncating cash runways in many venture portfolio companies.

Main street, public markets and venture/startup markets are interdependent, more now than ever given ubiquitous reliance on software, internet and technology across the economy. This was much less so the case in 2000, or even 2008. Today the link is tight:

Main Street: Main Street is hurting. Literally. Wade through the pile of Amazon and Instacart deliveries at your door and take but a few steps to realize small business, restaurants and many services through every city and town are in the shit. While government stimulus has helped – and we can likely expect more – it only puts food on the table and doesn’t yield the confidence consumers need to drive demand. Many startups sell to main street consumers or to the businesses that sell to them, so demand in most industries is undeniably muted.

Public Stocks: It is said that main street is today and the stock market is tomorrow, and this explains why employment can be down 600 basis points in 6 months while stocks return to previous highs over the same period. Okay, if that’s true then we might ask, “will the future (2021, 2022) be as good as 2018 and 2019?” That seems unlikely. Even if we had a vaccine today, the rest of demand and employment recovery is likely to take years, as it usually does following a recession. I am not a market timer, but right now it feels like the market is over-handicapping a quick vaccine and recovery.

So where does the venture/startup world fit in? In the end, public markets represent both a major input and output to the venture/startup model. Most funds invest money from institutional investors who hold a bulk of their holdings in public stock. When those go up, institutional investors “allocate” more to venture; when public stocks go down, those investors “allocate” less to venture. The public markets are also a major exit path for startups, both through direct IPO and M&A to public companies. When the markets drop, both paths deteriorate. So if the market drops again, which seems likely, there will be less money going into venture funds and fewer paths to exit for startups (or at least at lower exit multiples).

Admittedly, the above cycle is incredibly “macro” and “on average”, while startups and venture funds live by the power law. If you’re lucky enough to be a “COVID bump” startup or to have a few in your portfolio, that is terrific. However, the majority of startups are now growing slowly (in venture terms), chewing through the limited runway they worked hard to extend in March and April. This is what I refer to as the ticking time bomb of venture and startups. These runways expire en masse between late 2020 and mid 2021. 

As happened in March and April when VCs focused inwards, I anticipate a recurrence of inward preoccupation when this corpus of slower growing startups become “workouts”. Entrepreneurs and investors will have to pick winners and losers. This will lead to much fallout in existing portfolios but perhaps also a muting in excitement for funding new startups – at least for some time. (It will also be a good time for strong startups to buy weakened competitors and win their customers.)

You can’t be a VC without being an optimist, and I do believe tech is performing and will come through the other side of COVID stronger than ever. But we need to remember that everything is linked, and the current disequilibrium may yield to more pain in the short term.

Bootstrapping 2020

Crowdfunding, ICOs and COVID. What do these have in common? All three have at one point or another been described as a deathblow to venture. Venture has and will survive all three of these. While we’re in the early innings of the pandemic, an initial freeze in venture has thawed, even if at a more tempered cadence. VCs are screaming on twitter that they’re open for business, and even we have a signed TS with a company right now, so we can scream too.

But should startups take venture in 2020? That is a more complex question. Paul Graham’s much cited and seminal piece Startup = Growth is a great reminder of what venture capital is for: to fund rapid, steep growth. The cost of venture capital is high. Often cited as a 20-30% APR – a reasonable approximation for the average cost of capital for “successful” VC funds – the true cost to an entrepreneur who succeeds can be as high as 100% APR or more. Remember, if you succeed wildly, you have to cover the costs of your VCs’ failures.  Now, if that’s the case, you are probably much richer than the VC in the end, so it was worth it. Now back to the growth…

Raise your hand if you have rapid, steep growth in 2020. Uh huh. Most startups will have a terrible 2020 in startup = growth terms. We expect the majority of our companies to fall between a -25% decline (for some consumer and B2B transactional businesses) to a +50% (for stickier SaaS businesses). We are also lucky to have a few “COVID bump” outliers. More on that below.

When you’re swimming, it’s good to know where the rest of your pod is. Here is how we see the growth profile of startups in normal times and in 2020. Don’t get caught up on exact numbers, business model etc. This is meant to be illustrative:

In normal times, we see lots of startups growing 25 to 100% annually. Few of these get funded unless they have bulky ARR (say 5M and above), in which case they oftend find a “growth” investor with the right appetite.  Then there is a decreasing tail towards and above 200% annual growth. Most venture deals get done in this range with “hot” deals above 200% growth. 

In 2020, this distribution has shifted left, roughly centered around 0% growth, maybe slightly above. Then there is a long desert to a small second mode of “COVID bump” companies, where the hot deals are getting done now. These tend to be in e-commerce, virtual care, remote collaboration, online education… you know, the obvious. They get a lot of buzz and are exciting, but most of the announcements you see are companies receiving supported from insiders.

Venture capital is not for survival. It is very expensive if things work out later, so if you’re in the middle of the pack now, do your best to avoid taking venture until you emerge on the other side. Barring the fortune of being in the COVID bump – where pouring gas on the fire makes sense – I’m convinced that the best companies and happiest founders will be the ones who bootstrapped through 2020.

Preparing your startup for COVID19

Below is a letter we shared with our portfolio companies with tactical ways to prepare for the worst and hope for the best with respect to COVID19. Other startups may find this useful too.


Dear HPVP Portfolio Leaders,

With COVID19 an increasing reality both for public health and business, we know that each of you is considering how best to lead your company in protecting you employees, families and customers and ensuring resilience of your venture through a potential downturn and into a recovery.

Our portfolio company teams vary significantly in experience level. For some of you, this shock may not be the first you have weathered. It is for others. Regardless, each of us benefits from a thoughtful and planful approach to the potential challenges ahead. Below is a set of resources and considerations in charting (1) how to help protect the communities you lead and (2) how to protect your company to weather what may be ahead. While we all hope for the best, we must also plan for the downside. We will be in touch with you individually to see how we can help.


(1)    Protecting your community, people and theirs:

There is a growing chorus of questions related to employee and family travel, professional and social gatherings and proper hygiene in the face of COVID19.

Remember that in times of uncertainty, your actions and leadership are even more closely watched and mimicked by employees than in normal times. Also consider that while many startup employees appear “young and healthy”, employees may have conditions that they keep private, and “healthy” employees may otherwise come in contact with loved ones, community members and customers who are at higher risk from the virus.

We are not doctors, and most of you aren’t either, so we recommend following the guidance of public resources on what you should do. There are resources available from the CDC on down to municipal government; HPVP has been most attentive to the City of Chicago’s recommendations. We outline these in some detail with additional thoughts on events and domestic travel at the end of this email. Since you’ve heard much of it before, we’ll now shift focus to your companies.

(2)    Protecting your company:

Sequoia Capital published a letter they sent to their companies last week. The letter outlined how startups can anticipate and weather the effects of potential drop in demand, supply chain disruption and cancelled meetings and events. We highly recommend reading their letter and offer additional thoughts below:

Cash is king:

Almost all of our companies burn cash in favor of growth. When met with strong economic headwinds, the growth per cash burn ratio will decline (even to zero). Meanwhile the cost of that capital you are burning goes way up  – it gets harder for startups to raise capital. While VCs have raised historic amounts of capital in recent years, we may see more of it to stay on the sidelines as VCs’ own fundraising cycles lengthen. In short, if you planned on raising capital this year out of need, assume that it may be difficult to do so.

If you can’t count on fundraising or revenue for cash, the only thing left is expenses. We are not recommending our companies cut yet – pending learning more about COVID19’s impact in the next few months – but delaying hiring except for the most clear ROI cases is prudent (for example a project manager to run a large signed contract rollout versus just another sales person).

We should all be watching closely over the next few months with regard to further hiring or cuts pending feedback from sales in Q1 and early Q2.

If this sustains, it will affect everyone:

There are always arguments about what industries and business models will be affected the most in an economic shock. Certainly there are some that will be affected more by COVID19 than others (hospitality, travel, etc), but our position is that all startups will be affected. Even companies that don’t travel for sales – e-commerce, inside sales, marketplaces  – are all likely to be impacted. In a contractive environment, everyone contracts at one level or another.

Make sure your customers are very happy:

In tough times, resilience and stability – after extending runway – comes from keeping customers happy. Delaying price increases, allowing contract extensions or downsizing contracts if customers themselves are downsizing can go a long way in saving a customer that might otherwise be lost. Remember, they are facing the same headwinds you are.

Exercise flexibility in your teams to ensure continuity:

Seattle has seen large tech companies (MSFT, GOOG, FB, etc) ask or require employees to work from home. In several cases, these actions followed the diagnosis of an employee. Other examples were purely proactive to reduce risk of spread  – actions that are, in fact, in advance of CDC and local health departments’ recommendations for only high risk individuals to remain home. This shows us that an explicit or societally implicit expectation that companies shift to remote work could happen at any time or anywhere. We know of several companies “practicing” remote work by rotating 20% of their team each day to work from home over a week. This allows them to exercise “remote” muscles and ensure adequate tools and processes at home should they be needed.

Perhaps the biggest need for team flexibility relates to employees managing childcare if schools selectively or broadly close. Reduced or adjusted work hours may be necessary to accommodate school closures amongst your employee base. It would be a good idea to recommend that your employees begin to plan for this contingency and for them to know you have their back to reduce anxiety.

Make no little plans:

Our most tangible recommendation is to put a plan together over the next few days to address how you are approaching COVID19 with your team, customers and 2020 plan. A good plan would answer these simple questions:

  • What have you communicated to your employees, and how are you preparing them for a potential broad isolation scenario?
  • What actions are you taking now with respect to previously planned hiring?
  • What signals are you closely tracking over the next 4 to 8 weeks as leading indicators of demand softness?
  • What actions would you take in 8 weeks based on different outcomes of those leading indicators?
  • How much runway do you have now… and assuming no growth plus aggressive cost management in Q2?

You will probably want to share this plan with your board or perhaps have a board call; you never know where you might hear a good idea.

**** Recommendations from Chicago Health Department****

Explicit recommendations include:

  • Practice exceptional hygiene and social distancing: stay home when sick, wash hands frequently, and avoid handshakes
  • International travelers from Level 3 advisory countries (China, Iran, Italy, South Korea per the CDC) should self-quarantine at home for 14 days; International travelers from Level 2 advisory countries (Japan per the CDC) are not yet advised to self-quarantine but should monitor their health closely

What is less explicit in guidance from most public sources is what to do about domestic travel and gatherings/events. Of course, this is a big question for many of you who travel for sales and either hold or attend conferences. We are seeing more and more public events and conferences be cancelled. This began with large international conferences, then large ones hosted in the US and now seems to be expanding to more regional conferences in the US. It seems prudent at this point not to hold large events. Whether that is justified from a public health perspective is not ours to say, but expect that attendance will wane until there is more uncertainty about COVID19’s spread. Better to do things virtually. Likewise, with many conferences cancelled and many customer companies limiting visitor access, there are increasingly fewer reasons to travel domestically. A final policy on domestic travel is yours to make. At this point, HPVP has bagged all non-essential travel. You can see what other tech companies are doing here.