Photo by So Okamoto / Unsplash

Timing the market is impossible.

Actually I don't believe that at all. Do you remember '08? I was in college, but I remember it well. Kids were dropping out of school bc their parents couldn't pay for it. Friends' parents were losing houses, jobs, etc. It was pretty damn clear that there was a bottom approaching. Of course it wasn't clear exactly when the bottom was but in these cases close is good enough. How about at the beginning of COVID? I though that one was pretty clear too. The headlines in both cases presented the events as the end of days. It wasn't though, it was a bottom. Same with crypto winter #1 and #2 (maybe we're at the beginning of #3?). I suck at calling the top, but the bottom is usually hard to miss. Even now we sit with recent tech IPOs 70%+ off their all time highs in some cases. You can actually reason about their financials now (sort of), WOW!

Are we at the bottom right now? IDK :) Different post, I want to talk about startups, VC & micro PE.

With the current bloodletting in crypto and equities, I think we're entering a new cycle. It's a less capital rich environment where even VCs who used to shout "GROWTH AT ALL COSTS" a month ago now want to see revenue. It's not just VCs either, public markets want the same thing, hence the massive drops in companies like Coinbase, etc.

XO has been operating for the past 18 months in a stupidly inflated environment. Equities were downright silly, real estate ... man don't even get me started. Santa Monica real estate was particularly insane. I lost out on a place $300k over asking ... and it was about as close to a tear down as you can get (i.e. total P.O.S.). It had 19 offers. STUPID.

But, even in this environment, mostly thanks to Henry, we've been playing a (perhaps too) cautious game. The biggest hedge we can have against blowing up an acquisition is paying less for it. Have we perhaps missed out on some decent opportunities because we were being too conservative? Yes, I think so. But I don't regret them. Partly because for every bat shit crazy rally there is an equal and often harsher move back down to reality. It feels like we're beginning to have that moment now.

Do I think we're going to have a recession in 2022? I want to say yes (specifically just for Santa Monica housing prices). But I think no.  We already have 1 quarter of negative growth and only need one more for a technical recession. But that's a little arbitrary. We could be in a little one now. The COVID crash was technically a recession and only lasted two months. What I don't think is that we'll have two back to back 2 month recessions. Statistically that's pretty unlikely.

another 2 month recession is unlikely

So back to PE stuff. Multiples on marketplaces represent a sign of the times (namely irrational optimism). That might already be slowing down. I'd expect multiples to come down a bit (not a lot, as broadly I think at this micro scale these SaaS assets are under valued). We've bought great assets in the best of times, but now that the tide is starting to shift, we'll be buying assets in the worst of times. Historically for us as acquirers that's a good thing, we should be able to pick up a lot of distressed assets if shit really starts to hit the fan. But we're not firing on that just yet. I think there's more downside coming, but we're patiently waiting for the right opportunity.

But what about interest rates? We are looking to borrow from the SBA for our next deal. That is the best money around (if you can get it). It's generally 2.5-ish points above prime. And prime is going up. That also implies multiples will have to come down (SBA is pretty strict on debt coverage). So if you're payment to the SBA each month is $10k, the company will need to be making at least $15k per month or the deal is unlikely to get approved. This logic holds even as you move up the stack to large PE deals / debt.

Overall, I feel like XO has survived an extreme capital-rich environment (typically not the environment you'd expect to find great deals). Now another test is if we can survive a tight capital environment. Historically that's where PE does best since more stress on the ecosystem forces more people to sell whereas they wouldn't if they'd been able to raise more. Also interesting to think of the implication on time horizon vs innovation in a capital rich environment. (really quick, if you can borrow  a lot of money cheaply (or raise it), you can afford to look farther out into the future and build more ambitious stuff. If cash is scarce, then you have less of a time horizon to operate on since investors will need to see results before putting more cash in).

So no, I don't think we're at the bottom, but it's getting frothy. I do think once this downturn is in full swing, we should be able to pick up some really awesome companies at super reasonable prices. I have most of my cash on the sidelines ( I'm 12% allocated), and have in the past few weeks started more aggressively buying crypto and equities (yes ouch a little bit). And of course I have a healthy earmark for more XO acquisitions!

P.S. Hopefully none of you were holding UST or Luna or Avalanche this week. If you were, I'm sorry, and when we meet I'll buy you a beer.