Investing During a Crisis
European Straits | Friday Reads
Hi, it’s Nicolas from The Family. Here’s the second Friday Reads edition, focused on investing in a time of crisis and fighting COVID-19.
This is an edition of my newsletter European Straits accessible only to paid subscribers. If you’ve been forwarded it, you can subscribe so as not to miss the next ones.
The goal of this Friday Reads edition is to furnish ammunition that will let you dig deeper on whatever topics pique your interest 👇
This section is dedicated to sharing frameworks for investors deploying capital in tech startups.
So, I’m not breaking any news here: We’re in a serious crisis. COVID-19 has now been declared a pandemic; Saudi Arabia and Russia started an oil pricing war; Trump made a disastrous speech on TV. Now markets are in turmoil and we may be entering a new phase of deep economic crisis—and as usual, it won’t be contained to the financial system, but will affect real people.
Because they have such a particular mindset, investors interested in startups tend to rejoice at such circumstances. “Never let a good crisis go to waste” is what a venture capitalist friend emailed me today, and I agree. Indeed, there’s this idea that a crisis and its aftermath give birth to the most successful companies of the next decade. As I wrote in my book Hedge:
The  crisis contributed to boosting a new breed of technology company. Airbnb was first launched in 2008; its early success was due to people having difficulties paying the rent. Uber started operating the following year; it relied on the smartphone as the most convenient device to order a ride, but also on the reserve army of would-be drivers—all those who, for lack of a better job, were ready to go work on the new platforms of the “gig economy”.
The reality is that those companies didn’t thrive because they were founded in the aftermath of the financial crisis. Rather, they eventually became successful because 1/ they were led by exceptional founders and 2/ their value proposition was tailored to the particular context of the crisis: many people were out of a job, and many more were having trouble paying the rent.
On top of that, another macro-trend made it all possible. The original iPhone was introduced by Steve Jobs on January 9, 2007. Then Apple’s App Store launched in July 2008. With this new platform at their disposal, every company and developer in the world had an unprecedented path to distributing their product to a fast-growing segment of users clamoring for convenience.
As the late Clay Christensen explained many times, disruptive innovation comes about not only when a new entrant makes a better, simpler, cheaper value proposition. It also needs that long-term enabler—that is, a new high-technology core that emerges and radically changes the equation, enabling new entrants to challenge the status quo. In 2008, it was the App Store.
There’s another category of examples that investors eager to survive a crisis must keep in mind: the companies that were already operating before the crisis, but that then go on to survive it, eventually benefiting (and thriving) from the field being entirely cleared out.
Google is an interesting example of that. It began in January 1996 as a research project by Larry Page and Sergey Brin, and was incorporated on September 4, 1998—operating from the garage of Susan Wojcicki, now the CEO of YouTube. Then Google raised a lot of money (by the standards of the day): $100k from Andy Bechtolsheim in 1998, then around $1M from various angel investors (incl. Jeff Bezos) in 1999. Then it raised a $25M round with Kleiner Perkins and Sequoia Capital in June 1999.
And so Google was lucky enough to have LOTS of money in the bank when the dot-com bubble burst in March 2000. It provided them with enough runway to keep on searching for a business model, which they eventually found in 2002, the year when they first implemented the sponsored search auction system (which became Google AdWords).
Another interesting example is Amazon. As I wrote in my (long) 2016 piece 11 Notes on Amazon, the Amazon we know now is very different from what it was back in the 1990s. Today, it’s one of the most impressive tech companies on Earth, founded by the richest man alive. But back in the 1990s it was just a retailer trying to switch its business to an online distribution channel. Like every retailer, it was subject to a double curse: very low margins and constantly increasing competitive pressure—which was only greater because online sales came with almost no barrier to entry.
The situation was dire, and it could easily be seen by looking at Amazon’s accounts (remember that it went public in 1997, only three years after being founded). When the dot-com bubble burst in 2000, Amazon had never turned a profit, and it had burnt more than $3B in less than 6 years of existence. In short, it was almost wiped out when the music stopped.
But two things saved Amazon:
First, Bezos proved to be an exceptional manager who succeeded at turning the company around. Not only did he secure additional funding so that the company could weather the storm, he also decided to switch his strategic focus and have Amazon become a tech company rather than a mere retailer. This is what gave birth to AWS, now the main source of free cash flow for the entire company.
Bezos wasn’t alone in this fight. Of great help to him was Joy Covey, his then-CFO, who realized before others that if Amazon was a retailer, it could raise capital on the bond market with its future cash flows as collateral. Covey left the company shortly thereafter and then died in a tragic accident in 2013, so few people have heard her name. Still, she was instrumental in helping Amazon survive the big crisis that was the year 2000 in the startup world.
Both of these examples—Google and Amazon—are outliers and rather old. What all investors need to realize is that right now some ecosystems in the world (let’s say that is Silicon Valley, China, Israel, and maybe London) have managed to concentrate enough capital so that they can keep funding startups even in a time of crisis.
This was perfectly summarized in this discussion between Union Square Ventures’ Fred Wilson and my friend Carlota Perez: basically Fred explains to Carlota that her book is what convinced him and Brad Burnham to raise a fund back in 2002 when everyone else thought that venture capital was a thing of the past. When everyone else is retreating, that is when you should invest.
About that, here’s another quote from Hedge:
What matters is not what happens during bubbles, but what comes next. The price to pay for widespread instability is that some investors regularly lose money because they didn’t pick the winner. In this context, the stakes are clear. It’s critical that impoverished investors are able to rebound throughout the booms and busts of an economy driven by increasing returns to scale.
This is precisely what makes the strength of an ecosystem such as Silicon Valley. After the dot-com bubble burst, most in the Bay Area chose resilience and continued to found startups, to invest in them, and to seek jobs in the tech industry. Meanwhile, other parts of the world were traumatized and relinquished all interest in the nascent digital economy. That post-bubble behavior explains most of Silicon Valley’s competitive edge over other ecosystems.
Are there lessons that investors can draw as we’re about to enter a similarly turbulent period? I think so, and here is my shortlist of key ideas to keep in mind when considering an investment:
If you focus on early-stage startups, it’s too early to tell if they’ll be able to raise enough capital to let them weather the storm like Google and Amazon did back in the day. So your best chance is to focus on companies whose value proposition fits the current crisis particularly well. It can be about helping people in need, telemedicine, remote working, the energy transition, or other angles.
In any case, the startup you’re investing in has the highest probability of succeeding if it can tap later-stage investors in an ecosystem that is immune to the adverse effects of the current crisis. For European early-stage investors, the lesson is clear: make sure the founding team you’re betting on has the ambition and connections to go raise in London.
Look for today’s equivalent of the iPhone: the underlying trend that could change everything. Also, keep in mind that such a trend is not necessarily technological. It can be about societal change, geopolitical turmoil, the accelerating transition to the Entrepreneurial Age... or a global pandemic. Spotting the underlying currents and playing on them are qualities that make the best investors in these transitional times.
If you focus on later-stage investment opportunities, remember that early-stage investors are your allies. They invested based on a strong conviction as to what the founding team could achieve, not on an assessment of the state of the market or the kind of multiple they could grab. When the crisis comes, early conviction is what matters, not funding history.
Finally, have a look at unit economics. The current startup world can basically be divided in two. On one hand are startups whose growth was fueled by VC-funded subsidies, but the unit economics are bad: those are the ones that will typically go bust in times like these. On the other hand are the startups that have had such a hard time until now that they qualify for what Paul Graham labels the “cockroach” categories: startups that don’t die, no matter what. These are the ones you should double down on when the economy goes south!
Here’s an additional reading list to help you assess the current investment context:
Why to Start a Startup in a Bad Economy (Paul Graham, Essays, October 2008)
Better Get Used To Those Bubbles (me, The Family Papers, March 2016)
The 2008 Crisis Is Not Over (me, European Straits, December 2017)
Prelude to Crisis (John Mauldin, Evergreen Gavekal, January 2020)
What's Happening With the Stock Market? (me, European Straits, February 2020)
This Is When Hedge Funds Are Supposed to Outperform. Here’s What’s Actually Happening (Alicia McElhaney & Amy Whyte, Institutional Investor, February 2020)
That 1970s Feeling (Kenneth Rogoff, Project Syndicate, March 2020)
Bear Essentials a guide to navigating a bear market (Goldman Sachs, Global Macroscope, March 2020)
Two epidemics combine to make for a ‘dangerous time for the stock market,’ Nobel Prize–winning economist warns (Shawn Langlois, Market Watch, March 2020)
This Wednesday, the free edition of European Straits was dedicated to waging a war against COVID-19: What If We’re at War? Here’s a reading list if you want to go further.
History and pandemics in general:
The Black Death, 1348 (EyeWitness to History, 2001)
How the Horrific 1918 Flu Spread Across America (John M. Barry, The Smithsonian Magazine, November 2017)
The dark and complex history of quarantine goes back to the Middle Ages (Alicia Lee, CNN, March 2020)
How Coronavirus Compares With 2009's H1N1 in Spread and Reaction (Justin Fox, Bloomberg, March 2020)
How can China build a hospital so quickly? (Sophie Williams, BBC, January 2020)
Wuhan: a tale of immune system failure and social strength (TJMa, Chublic Opinion, February 2020)
The Coronavirus and Xi Jinping’s Worldview (Kevin Rudd, Project Syndicate, February 2020)
Is the world fortunate that the coronavirus hit China first? (Alex Tabarrok, Marginal Revolution, February 2020)
The theater of state power (Andrew Baston, Andrew Baston’s Blog, February 2020)
An Interview with Bill Bishop of Sinocism about COVID-19 (Ben Thompson, Stratechery, February 2020)
Inside China’s All-Out War on the Coronavirus (Donald G. McNeil Jr., The New York Times, March 2020)
Coronavirus in China: The most important lessons from China's Covid-19 response (Julia Belluz, Vox, March 2020)
Will the Coronavirus Topple China’s One-Party Regime? (Minxin Pei, Project Syndicate, March 2020)
Let’s take a look what has been required to stop COVID-19 in China (Nicholas A. Christakis, Twitter, March 2020)
Covid Observations from Beijing, March 11 (Dan Wang, March 2020)
I lived in Beijing during the 2008 Olympics and this was exactly why i got worried early (Jack Connor, Twitter, March 2020)
Other Asian countries:
Life in Singapore in the Time of Coronavirus (Amanda Jaffe, The American Interest, February 2020)
What America can learn from Taiwan's coronavirus response (Kelsey Piper, Vox, March 2020)
Preparing for Coronavirus to Strike the US (Zeynep Tufekci, Scientific American, February 2020)
How Will Tech Help in a Time of Pandemic? (Kara Swisher, The New York Times, February 2020)
Covid-19 Will Mark the End of Affluence Politics (Matt Stoller, Wired, February 2020)
Difficult times (Ryan Avent, The Bellows, March 2020)
How America Can Beat COVID-19 (James K. Galbraith, Project Syndicate, March 2020)
Our Capitalist, Corporatist Country Is Drastically Unprepared for the Coronavirus (Elie Mystal, The Nation, March 2020)
Fighting the Coronavirus, and Individualism (Meghan O’Rourke, The Atlantic, March 2020)
America's Coronavirus Response Has Started Slow But Will Improve (Tyler Cowen, Bloomberg, March 2020)
As COVID-19 spreads, we’re learning more about the missteps early in the outbreak that could’ve kept it under wraps. (Lydia DePillis, Twitter, March 2020)
Italy's Response to the Coronavirus (Anne Applebaum, The Atlantic, March 2020)
💭🦠 Coronavirus on the Latin Bridge (Azeem Azhar, Exponential View, March 2020)
Coronavirus: Italy's Lockdown Tests the Limits of Democracy (Fernandino Giugliano, Bloomberg, March 2020)
Why Are We More Worried About Coronavirus than Climate Change? (Joe Wiggins, Behavioural Investment, March 2020)
The coronavirus will reveal hidden vulnerabilities in complex global supply chains (Geoffrey Gertz, Brookings, March 2020)
The “Gift” of Coronavirus (Peter Zeihan, Zeihan on Geopolitics, March 2020)
Western Democracies on Trial as China Halts Coronavirus Spread (Yaroslav Trofimov, The Wall Street Journal, March 2020)
‘Network Effects’ Multiply a Viral Threat (Niall Ferguson, The Wall Street Journal, March 2020)
The coronavirus is a stress test for the U.S. and E.U. (Ishaan Tharoor, The Washington Post, March 2020)
Coronavirus and the Clash of Civilizations (Bruno Maçães, National Review, March 2020)
Responding to COVID-19 in general:
Why preventing pandemics & improving biosecurity is incredibly important (Roman Duda, 80,000 Hours, March 2016)
Coronavirus: Why You Must Act Now (Tomas Pueyo, Medium, March 2020)
💭 After the virus (Azeem Azhar, Exponential View, March 2020)
What is the proper fiscal response to the coronavirus? (Tyler Cowen, Marginal Revolution, March 2020)
Best Coronavirus Response? QE Plus Infrastructure Spending (Noah Smith, Bloomberg, March 2020)
Doctors and Patients Turn to Telemedicine in the Coronavirus Outbreak (Reed Abelson, The New York Times, March 2020)
Coronavirus and the comeback of the administrative state (Janan Ganesh, The Financial Times, March 2020)
From Normandy, France 🇫🇷