Some people, and you’ll find plenty of them in the value crowd, are skeptical of high growth, low or no profits regardless of what else is happening in the economy and would rather find an unloved firm without any headlines than argue about when Twitter Inc (NYSE:TWTR) will become profitable. Investors are used to ignoring such consistent naysayers, but when venture capitalist Marc Andreessen, who has made his fortune in the tech world, says that there’s a problem it’s another matter entirely.
Andreessen: Cash-burning startups will struggle when the market turns
In one of his signature multi-part Twitter-storms (h/t William Alden at DealBook), Andreessen warns that startups with high burn rates (aka negative cash flow, the reason value investors steer clear) could face serious problems if the market takes a turn for the worse and financing becomes harder to find, using the VAPORIZE (all-caps his) multiple times throughout.
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It’s not just that some companies will run out of cash, there are all sorts of other problems associated with a high burn rate that Andreessen doesn’t see being addressed. Spending all that money means that the organization is growing and becoming harder to manage, with greater communication overhead and a “bigger bulldog to feed” in your next funding round. Andreessen also says that companies with high burn rates are too used to throwing money at a problem in the form of new hires and have never been forced to increase productivity with the workers they already have.
Even worse, a company that’s been in a hiring frenzy will have a hard time changing course and laying people off. The most talented employees join a startup because they believe it will be the next big thing and they want a share, if a couple rounds of layoffs change that perception a startup could have trouble keeping the talent it already has let alone attracting someone new, which can easily turn into a self-fulfilling prophecy.
‘Down’ financing rounds will come with serious strings attached
Even companies that manage to find new funding to avoid these problems might not like the terms that come along with it.
“That nice hedge fund investor willing to hit your valuation bar? Imagine him owning 80% of co after down round. How nice will he be then?” asks Andreessen. And when M&A activity slows down after the next market turn, getting bought out of your mess by Google Inc (NASDAQ:GOOG), Facebook Inc (NASDAQ:FB), or some other tech giant just isn’t going to happen. Andreessen should know, he’s on the board of a few of them.
In case there’s any doubt what Andreessen thinks startups in the habit of spending should be doing right now, he ends with a one word tweet.orry.”