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Building a Moat in a Bubble: Navigating Today’s Financing Environment

May 5, 2015

This post originally appeared in TechCrunch.

Two weeks ago, the NASDAQ recently topped its all-time high set in March 2000, and today, there are over 50 private “unicorn” companies with valuations of more than $1 billion. Private tech companies have easier and faster access to capital than ever before—financing rounds of $100 million or more (which would have been considered a “blockbuster” IPO 15 years ago) are increasingly common for private companies.

Are we really partying like it’s 1999? Are we in a boom or bubble? And, most importantly, what should entrepreneurs today do about it?

Having just closed Menlo Ventures XII, a $400 million fund focused on early- to growth-stage technology companies, we recently spent some time thinking about these questions. In our 39 years of history as a firm, one fact that’s been clear to us is that technology is a cyclical business. While it’s tempting to draw parallels to prior time periods, knowing exactly where we are in the cycle is extremely difficult, if not impossible. There are some similarities between today and the late 1990s, but also some very noteworthy differences.

First, Internet business models today are well-tested and well-understood. Whether through advertising, premium subscription services or marketplace transaction fees, there are numerous companies that have demonstrated exactly how to monetize “eyeballs.”

Second, there are roughly 10x the number of Internet users in 2015 as there were in 1999, and those users spend 10x more time online than they did then. Not to mention the 1.5 billion worldwide smartphone users in 2015, which were non-existent back then. Companies like Uber and Poshmark simply could not have been started in 1999. All of this creates a vastly larger opportunity to monetize consumers who are now well accustomed to spending both time and dollars online.

Finally, while some may argue that high-growth technology companies are richly valued presently, today’s valuations pale in comparison to what we saw in 1999. The median technology IPO in 1999 had $12 million in annual revenue, and the median revenue multiple was 26.5x. Compare that to 2014, when the median annual revenue was $90 million and the median revenue multiple of 6.2x.

We also have a much larger addressable online market, a thriving mobile ecosystem, and well-proven business models. A compelling case can be made for the fact that we’re poised for an extended boom, not a bust.

But it’s impossible to know for sure how the public and private equity markets will behave in the near term. Given that inherent uncertainty, the real question is, what should companies do about it?

Build a Moat Around Your Business

It’s prudent for high-profile private companies to take advantage of the favorable financing environment we’re seeing today. Menlo Ventures has been fortunate enough to invest in market-leading companies like Uber, MachineZone, Warby Parker and Dropcam—all of which have successfully raised large financing rounds at substantial valuation increases from our initial investment.

Raising a large round can be an effective way to build and protect your business. If today’s funding environment gets worse, companies chasing at your heels will have a harder time doing so.

Don’t Assume the Status Quo Will Last Forever

The only fact that’s certain in technology is change—today’s so-called “bubble” market can turn to bust overnight. It’s important to opportunistically look at accelerated growth options based on a strong fundraising environment.

But building an operating plan that depends on successively larger and higher-priced rounds to materialize in the future could mean disaster. If you find yourself too fixated on that deep moat you’re building around your business, you may just fall right into it yourself.

Don’t Let the Tail Wag the Dog on Operating Decisions

Too often, entrepreneurs let the amount of capital available to them determine how to operate their business rather than the other way around. Every company has a natural cadence of growth that needs to be respected, regardless of the external fundraising environment. There’s a limit to how many high-caliber engineers, salespeople, and marketing executives companies can recruit and train in a given period—trying to hire too much faster could mean the quality bar gets lowered on new employees.

For consumer-facing services, attempting to launch into hyper-growth mode through paid marketing—when basic things like user experience and retention still need to be addressed—could prove harmful in the long run. If you’re baking a soufflé, turning the temperature all the way up to 500 degrees (just because you have a powerful enough oven) isn’t going to result in a high-quality product faster.

The right decisions for any individual company are always case-specific and dependent on the particular market, competitive landscape and myriad other factors. It’s important for entrepreneurs and boards to continuously evaluate their own situations, considering both the macro environment and company-specific factors, to make decisions that maximize value in the long term.