
If We’re in a Bubble, What Should an Entrepreneur Do? - treblig
http://benjamingilbert.net/if-were-in-a-bubble-what-should-an-entrepreneur-do/
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mathattack
My 2 cents... In 2008 and 2009, when so many of my most talented friends were
unemployed for the only time in their career, I observed, "It's a once in a
lifetime opportunity to start a company. Better to be starting a firm when
talent is plentiful and money is scarce than the other way around."

So what to do now that it's the other way around? (Independent of calling it a
bubble, money is relatively more plentiful than talent than any time in the
past 15 years)

An entrepreneur should take the money and use it to build talent. What's this
mean? Be selective about money, get it from investors with as long a time
horizon as possible, and make sure that it's enough to last a while. Then hire
people with great potential who may be overlooked by the market. Use the money
to grow them as they grow the company, and create an environment where they
might want to stay.

If you're not that patient, just take the high valuations and use it to buy 1
or 2 superstars whose equity is underwater at Google.

~~~
j-conn
Thanks for this.

 _get it from investors with as long a time horizon as possible_ Can you
elaborate on how to evaluate this? I'd imagine you could just ask them if you
already have a relationship, otherwise by looking at the age of their fund?

~~~
mathattack
You hit the first two suggestions - age of fund is a big clue, and just asking
them. Reputation of the firm matters a lot too.

If you're up front about your expected burn rate and the amount of funding
you're asking for, that will help select the right group too. (You can't ask
for 10 years of funding, but you can go for more than the year that many
settle for)

------
patio11
It's difficult for many entrepreneurs to hedge, particularly young or first-
time entrepreneurs, because a supermajority of their net worth is in their
company. If you own a software company and have $10k in your IRA there is _no
option available_ which causes that IRA to suddenly be worth an appreciable
portion of the value of the software company given some event which severely
compromises the worth of the software company.

The best option available if you're concerned about sector-specific or firm-
specific risk is to decrease your exposure to your own company. For example,
if your company has already created tangible economic value, you'd do
something like a secondary sale while raising a new equity round, such that
part of the round goes into your pocket rather than the company's coffers.
You'd then take that money and then do anything other than putting it into a
high-growth tech company.

This is becoming much more common than it used to be, to my understanding.
Historically VCs preferred to have founders be "hungry for an exit" (which
was, ahem, so that VCs would have a superior negotiating position), but these
days social acceptability of cashouts is increasing as a) the market favors
entrepreneurs and b) VCs are starting to cotton onto the fact that early
acquisition offers (which murder VC returns) are radically more attractive
when you have $600 in your checking account than when you can comfortably
contemplate e.g. a wedding, childbirth, or a home purchase (well, OK, maybe
not a home purchase in the current real estate market) without suffering
crippling amounts of financial anxiety.

Given that one has a non-trivial portion of their net worth outside the
company, there exist options for hedging, but given that you're probably
better at selling software than on financial alchemy you should probably stick
with what you're good at.

That said, you might do something like I did, which was e.g. pick a publicly
traded company which would get shellacked if your sector got hit and buy
deeply out-of-the-money puts on them. (I picked Salesforce and spent ~$500 on
an options position which pays out only if they either have Enron-sized
accounting issues or SaaS gets punched in the face. It expired valueless. I'd
have re-upped it for another year but didn't anticipate my net worth and
professional career to both be 90%+ SaaS-weighted for most of this year.)

~~~
7Figures2Commas
> That said, you might do something like I did, which was e.g. pick a publicly
> traded company which would get shellacked if your sector got hit and buy
> deeply out-of-the-money puts on them. (I picked Salesforce and spent ~$500
> on an options position which pays out only if they either have Enron-sized
> accounting issues or SaaS gets punched in the face. It expired valueless.
> I'd have re-upped it for another year but didn't anticipate my net worth and
> professional career to both be 90%+ SaaS-weighted for most of this year.)

This is not good advice. _Buying_ options is a fool's game. The vast majority
of retail options buyers lose money, which isn't surprising given that upwards
of 70% of call and put options expire worthless. When it comes to losing
money, buying deep OTM options is by far the best strategy.

If you want to play the options game, you are statistically far more likely to
not lose money, and to make it, by selling options.

~~~
patio11
That's the point of an insurance policy: you want to say next year "Darn, I
spent a small predictable amount of money and nothing bad happened so I got
nothing for that money."

The more pertinent criticism of this strategy would be "Patrick, there are all
sorts of ways for the value of your company to go to zero, including in the
middle of a sectoral decline, without causing the options you purchased to be
worth enough to meaningfully cushion the blow."

~~~
7Figures2Commas
A protective put against an equity position can function like an insurance
policy. For example, if you owned a large position in CRM stock and were
sitting on significant unrealized gains but didn't want to sell, you could buy
CRM puts to protect your equity position. Of course, there are other
strategies (like a collar) that are probably going to make more sense in many
scenarios.

Buying a deep OTM put in a single company as an "insurance policy" for your
privately-owned SaaS business is patently silly. The correlation, if any, is
far too weak to be meaningful but even if you believed there was some
correlation, to follow your own criticism of your strategy, I find it hard to
believe that $500 worth of puts would provide protection unless you have a
tiny business. Even if the value of your puts grew by, say, 3900%, an entirely
unlikely scenario, your dollar gains would still only be $19,500.

So I'll repeat: folks should not consider buying puts (and deep OTM puts at
that) as you suggested.

------
codingdave
Bootstrap. None of this has any impact on you if you bootstrap your company,
and run it profitably, with the intent to keep running it profitably.

~~~
adventured
This is partially true.

The non-true part of it, is that if you see half of your business vaporized in
the downturn, your profit margin while bootstrapping will be erased and you'll
lose money. That can easily happen at _nearly_ all sizes in terms of costs
drowning you.

$2m in sales, $200,000 in profit. Your sales suddenly fall to $1m (and in a
bubble bursting scenario, that happens at warp speed, it'll make your head
spin), I'd almost guarantee your costs will wipe out your profit in that
situation (assuming you're not a one person shop). Then suddenly you're firing
people, and it rattles your entire organization; existing customers lose
confidence and switch to bigger competitors or back to internal solutions.

The dotcom bubble bursting was a very dramatic example of this, and the speed
at which it killed good companies was intense. Where good companies that were
modestly profitable still saw half their business killed off, and it was
simply too much to bear because all of that damage doesn't happen in a linear
fashion, it has immense knock-on chaotic effects to your business.

~~~
codingdave
Those risks can be mitigated with a scalable business model, which scales up
or down. When I first starting getting into the details of running a business,
I was taught to always build in a core transaction that is the basis for the
revenue. You then budget your expenses based on the actual costs and profit
from a single transaction, and scale based on how many transactions actually
occur. If your sales slip, your budgets decrease, and you may need to let
people go, or take other actions to scale down... but the business itself is
still running at a profit. The scenario of having to scale down sucks. But it
doesn't have to move you into the red.

I admit that not all business plans can follow this philosophy, in particular
if you are of the thinking to get traffic now and monetize later. And I'll
work for people running companies who don't follow this philosophy, but I
won't run one myself.

------
JimboOmega
There's a bunch of options.

One of the most obvious, as an investor, is to hoard cash now. When the bubble
bursts, your dollar will go further; you'll get better valuations, companies
will be more desperate, etc.

As an entrepreneur, time to make hay while the sun is shining; raise cash now.

Looking for hedge? Consider SF real estate. A big part of what's keeping it
sky high is the proliferation of startups in SoMa, making living in the city
an attractive option. If those jobs all disappear, I doubt there will be more
than enough Tech shuttles to bring all those people back down to the valley -
and the depressed labor market _should_ lead to lower wages.

I do think there's tremendous opportunity in the hiring space for a good
startup, but I have no idea what that is. The "Bad Hire" risk is magnified for
small companies... so if anything, that's something that does better in this
phase of the business cycle, when hiring is high.

~~~
pinky1417
How would SF real estate be a hedge if the regional tech labor market becomes
depressed? Lower wages in SF and the surrounding area should depress real
estate prices in SF, not increase real estate prices.

~~~
adventured
It won't be a good hedge. You'll take a bath on that real estate if the
venture capital market seizes up (eg with higher interest rates and were a
bubble to pop). Rents will fall, vacancies will soar, and a lot of
construction will halt.

I can't see what the parent meant, such that it makes sense as a hedge. The
hedge (if one were really worried about a bubble popping) on SF real estate
would be to sell right now - if you can get a high price - and rent.

~~~
JimboOmega
I'd never enter the SF renter market as a landlord, given that it can
basically only go down.

I meant to suggest it as something you could short - it's an asset class that
is tied to the health of the sector. Since it's hard to short the companies in
the sector, you could short the RE as a proxy.

------
hashberry
I have been worrying about the economy being in a bubble for the past year. It
stagnates you. It's best not to obsess over it. It's only a bubble if a crash
occurs, and no one can predict that, only play the guessing game.

------
nosuchthing
Why are there bubbles in the first place?

Would it not be in the interest to prevent trillions of dollars in losses due
to economic bubbles bursting? Or is that part of a finance game where shorting
companies becomes very profitable?

~~~
jfish3474
If you can figure out why bubbles happen and are able to predict them then
there's a Nobel in economics waiting for you

~~~
Terr_
_Why_ a particular bubble progresses is easy, especially in hindsight. It's
predicting its future that's hard.

