How Silicon Vally Startups Adapted To Crash Warnings and Survived

Given the choice between adapting or dying, many startups appear to have chosen the former. Evolution works. JL

Katie Benner reports in the New York Times:

Young companies have laid off staff. And many entrepreneurs are no longer able to demand whatever valuation they please for their companies.It is precisely these adaptations that have allowed many Silicon Valley start-ups to stick it out — for now, at least.

Evernote, a Silicon Valley start-up that makes a note-taking app, was supposed to be dead by now.

After a stratospheric rise over the last few years, during which investors poured about $270 million into the company and valued it at $1 billion, Evernote hit hard times last year. Naysayers said the company had overexpanded, was spending too much money and would be destroyed by competitors. The start-up soon became the poster child of a coming collapse in Silicon Valley.

Twelve months later, Evernote has cut back on staff, eliminated employee perks like free housecleaning services, simplified its product line — and stabilized. The number of customers who pay for its file storage and sharing product is on track to grow as much as 40 percent this year, and the company is hiring again.

“Here we sit, a year after we were supposed to die,” said Chris O’Neill, 43, chief executive of the start-up, which is based in Redwood City, Calif. “It was hard for employees to readjust expectations. They had only known a world where another fund-raise was just around the corner.”

Silicon Valley start-ups were set to face a great reckoning in 2016. Yet the crash hasn’t happened.

Last year, many tech executives, venture capitalists and entrepreneurs were convinced that a multiyear boom that had propelled young companies to great heights could no longer sustain itself. Some said it would end apocalyptically. Michael Moritz, an influential start-up investor at Sequoia Capital, declared many of the companies “the flimsiest of edifices.” Bill Gurley, a venture capitalist at the Silicon Valley firm Benchmark, proclaimed that the start-ups would bite the dust. “Winter is coming,” others intoned.

The worst fallout may yet come, but many of the start-ups have hung on. Across Silicon Valley, engineers are still commanding annual salaries that average $136,000, according to Hired, a recruiting firm. Demand is brisk for $4 buttered toast, and office space rents remain near record highs. The biggest start-ups, like Uber and Airbnb, continue to land billions of dollars in funding. And investors are shoveling money into venture capital funds, which raised so much cash in the first half of this year that it rivaled the amount raised in all of 2015.

For all of the hand-wringing, “there just hasn’t been much of a downturn,” said Paul Buchheit, a managing partner at Y Combinator, a prominent start-up incubator that nurtured companies including Dropbox and Airbnb. “I don’t even see many companies going out of business.”

Photo

Sean Behr of the parking service Zirx at its offices in San Francisco. Credit Jason Henry for The New York Times

That is not to say there has been no adjustment. Some smaller start-ups, like the live-streaming app Blab and the on-demand private chef company Kitchit, have collapsed into Silicon Valley’s dead pool. Other young companies have laid off staff. And many entrepreneurs are no longer able to demand whatever valuation they please for their companies.

Yet it is precisely these adaptations that have allowed many Silicon Valley start-ups to stick it out — for now, at least.

“The start-up world did heed the warnings,” said Max Levchin, a former employee and a founder of PayPal and the chief executive of Affirm, a lending start-up in San Francisco.

Silicon Valley’s innovation engine continues even with the survival of so many start-ups — and not just the fittest — because of the abundance of venture capital. There has been a proliferation of new enterprises in up-and-coming fields like artificial intelligence, robotics and virtual reality, creating potential areas of growth for Silicon Valley technologists to build on next.

For techies who have been grappling with the not-yet-a-crash environment, the adjustment in their outlook is evident in their speech. Entrepreneurs who once talked about how fast their start-ups were growing are now spouting from a bible of fiscal responsibility.

Sean Behr, the chief executive of the parking service Zirx, epitomizes the change. The company, named after the Ukrainian word for star, was in the “on-demand” space, providing valet parking with the touch of a smartphone button. Mr. Behr said his goal was to make all of Zirx’s consumers feel like stars.

But each customer was so expensive to acquire and serve that Zirx lost money and consumers in all six cities where it operated. By late last year, Zirx, a San Francisco start-up that had raised $36 million, had only about a year’s worth of cash left.

So in January, Mr. Behr, 41, walked his employees through nearly 40 PowerPoint slides detailing the company’s precarious finances and explained that Zirx needed to take drastic actions. That month, he told customers Zirx was shutting down its on-demand businesses where valets would park cars for any customer who asked and would instead focus on more lucrative corporate clients.

“Investors used to say grow, grow, grow and don’t worry about costs,” Mr. Behr said. “Now you’re encouraged to not run out of money and make sure you’ll be around.”

Photo

Zirx was losing money in its on-demand business and decided to serve only more lucrative corporate clients. Credit Jason Henry for The New York Times

Today, Zirx is profitable in eight of its nine markets, he said. The company has preserved $10 million from its last financing round to keep in the bank for a rainier day.

At Bannerman, a 16-person security guard start-up based in San Francisco, Johnny Chin, the chief executive, also narrowed the company’s focus after warnings of a crash. While the start-up once pursued several types of customers, it began concentrating on serving only medium-size offices and property managers.

The company was losing money last year, but it is now profitable. Start-ups “started to cut their most frivolous spending,” said Mr. Chin, 30. “People are just cautious. It’s healthier.”

Other entrepreneurs have a newfound air of practicality, no longer shooting for their companies to be the next tech behemoth like Facebook.

Ken Denman, chief executive of the artificial intelligence start-up Emotient, was trying to drum up more money for his company last year when he heard the talk about a coming start-up calamity. So to hedge his bets, he started talking to potential buyers, too.

“In 2013, I wouldn’t have thought about selling,” said Mr. Denman, 58. But all the concerns “encouraged folks to behave in whatever way would give them the greatest chance to succeed.”

In January, he sold his four-year-old company for an undisclosed amount to Apple, where most of his team now works. “I looked at all the variables and wanted to do what was the best thing for the employees and the company,” said Mr. Denman, who is taking a break after the sale.

A Silicon Valley start-up crash may still take place, especially if the stock market tanks or if there is a financial shock to the system. And some tech investors like Mr. Gurley, the venture capitalist, are still sounding the alarm. In April, Mr. Gurley wrote a blog post that laid out how venture investors remain overcapitalized to a dangerous degree, which made investing in start-ups more risky.

While there has been no crash since then, he does not regret any prognostications. He said he was glad if young companies had stopped overspending

because of his warnings.

“Funding for just anything under the sun has gone away,” Mr. Gurley said. “I spoke out because the longer those things go on, the worse things end up later on. This is the impact I wanted to have.”