Impact of the ongoing public market meltdown on startups?

Public markets are, by definition, public. That means any obvious rise and fall in them creates much more news buzz than the obscure private market such as startup funding and valuations.

There is, both historically and theoretically, a correlation between public market values and private market valuations. This is not just because most successful startups will eventually hit IPO and hence become public companies, but also because in the valuation models of private companies, public comparables are often included despite the obvious differences in growth potential and therefore valuation multiples.

When public market rose in the past couple of years, so did the valuation of private startups. If the market takes a hit in the months to come, it's reasonable to expect a correction on the valuation of startups that are raising new rounds. In the worst case scenario, a startup might be forced to take a down round, which might trigger some embedded rights in the contracts with previous investors, which leads to further dilution or a complete impasse in fundraising.

In the later case, the startup might run out of cash and roll over.

The startups that are not raising money, however, won't be affected much, at least not beyond mental impacts.

The successful startups that do not need to raise money are those that achieve positive operation cash flows and therefore could sustain their own growths if the operating profit margins are good enough.

In the world of SaaS- and Freemium-based lean startups, it's kind of difficult to imagine that such startups exist. However, the best hardware startups are almost all of this kind, achieving self-sustaining growths earlier than their lean friends.

This is because, compared to the sometimes rather extreme payable/receivable term mismatches – compounded by the uncertain conversion rates – that most lean startups face, hardware startups are in relatively predictable working capital model.

Payments to contract manufacturers usually come in 1-month or 2-month periods and in 50/50 or 30/70 downpayment-FOB terms.

Receivables depend on consumers behaviors but with fast-growing startups, i.e. with popular hardware products. the demands usually continue to outstrip supplies so the firms could focus solely on inventory managements instead of trying to predict the reaction of the frivolous consumers.

Adding all this together, a great hardware startup can actually grow to dominance with the positive operating cash flows it's able to generate within itself, without relying on external funding especially past a certain stage.

Case in point would be Fitbit, whose last round before IPO was the $42M Series D back in August 2013, which in VC clock is like ancient history. With no further funding, the firm was able to grow its revenue from a bit south of $300M in 2013 to $745M in 2014. The amazing successful wearable firm is slated to hit $1.4B revenue in 2015 and generating a healthy chunk of operating cash flow thanks to its high gross/operating/net margins.

The same could be said with Misfit Wearbles, a Hardware Club member. Despite the lack of public info, one can infer from an interview that Forbes did with our friend Sonny in December 2014 when they raised a $40M Series C:

Sonny Vu, who co-founded Misfit with former Apple CEO John Sculley and another partner Sridhar Iyengar in 2011, explained that the partnership is more about strategic alliance than about money– Misfit isn’t exactly short of cash after their $15.2 million series B round led by Horizons Ventures a year ago.

The surprising popularity of Misfit products in the Chinese grey markets prompted them to investigate and decide to bring in prestiged Chinese investors like our friend Hans Tung of GGV Capital, Xiaomi and JD.com. It's not really capital that's needed to sustain the known expected growth of the firm but rather an alliance to explore a previously unplanned market — a humongous one no less.

Good startups like Misfit or pre-IPO Fitbit should not worry too much about the public market meltdown, at least not beyond its impact on consumers' sentiment. This is because they do not need to raise new capital so they are not exposed to the valuation correction in the short term.

In summary, startups that are able to generate positive operational cash flows and grow by themselves will therefore not feel the impact of the imminent public market correction, or as Fred Wilson put it in his latest blog post "Why Capital Markets Matter":



Manufacturing for startups hinges on long-term interest alignment

Hardware products (and therefore startups) that are NOT