Startups are realizing there’s no Plan B: They have to survive the bad times like ‘cockroaches’

One by one, startups are having their strategic options taken away from them.

A turbulent stock market means that it’s a bad time for a startup, even a high-profile one, to hold its IPO. Meanwhile, venture-capital firms are getting skittish about sinking more investment cash into startups, particularly those with more hype than revenue.

There’s always been a third option for startup founders: If you can’t raise cash and you can’t go public, you can maybe sell yourself to a bigger company like Google, Microsoft, or Salesforce.

“Selling our company has always been a fallout plan, a Plan B,” said Todd McKinnon, CEO of $1 billion identity-management startup Okta, on stage at an Andreessen Horowitz-sponsored panel event on Thursday.

But fears of another recession mean that even the biggest tech titans are hoarding their cash, and mergers and acquisition deals are on a serious lull until things work out. And even those that are still shopping — like Cisco and Salesforce — aren’t going to be paying premium prices.

And other tech titans are distracted by mergers, such as Dell’s $67 billion buyout of enterprise IT giant EMC — a deal that is distracting big buyers like Dell, EMC, and VMware these days.

This means a serious wake-up call for enterprise-focused startups, say the founders on the panel.

Second option

As McKinnon explained, when Okta started in 2008 — with early funding from Andreessen Horowitz — it was one of a few companies in its field, providing a way for businesses to give its employees one username and one password to log in to all of its various apps and web services.

Over the years, though, giants like Salesforce got into the market with a competing product to Okta. And Microsoft eventually grew out its enterprise-standard Active Directory tools to do much of the same thing.

“Oh, s—, at least maybe we can sell the company,” McKinnon remembers thinking.

Okta never intended to sell, McKinnon says. But when things weren’t looking great competitively, he says that the executive team were always comforted that acquisition was an option that was pretty much always on the table. It took some of the pressure off.

“Well, at we have that M&A deal as a second option,” McKinnon says.

Andreessen HorowitzAndreessen Horowitz General Partner Peter Levine.

The changing market has taken that second option off the table, he says.

McKinnon marks 2014’s IPO filing from cloud-storage company Box as a watershed moment, when it was revealed that it was spending way more to bring on new customers than it was booking in revenue. The whole thing turned investors away from “people selling dollars for $0.80,” he says.

Box has had a strained relationship with Wall Street since that IPO, seemingly vindicating McKinnon’s perspective.

The lesson Okta learned, he says, is that it needs to get its spending under control, trying to boost revenue while minimizing its spending. In other words, Okta had to stop acting like an outside company would save it and to start acting like a company that’s in this for the long haul, McKinnon says.

The benefit: In addition to generally being a healthier company, Okta is now in acquisition talks with as many as four “little companies” whose price tags were too high before the market started to shift downward.

Cockroaches

Suhail Doshi, CEO of $865 million data-analytics startup Mixpanel, had a similar experience. Instead of asking how to keep growing or how to raise cash, he says that the real challenge at Mixpanel is figuring out “how to be a cockroach.”

“The thing that happens when you’re able to raise an ungodly amount of money,” is that without discipline, “it’s easy to spend a lot of it,” Doshi says.

Doshi should know: Mixpanel raised $65 million in late 2014, in a round led by Andreessen Horowitz.

Amid the eternal talks over whether or not tech is in a bubble, Doshi says he went to a banker with whom Mixpanel had been doing business. He asked if he thought the financial world was heading for disaster, or if it were likely that Salesforce or Google would go on a spending spree and buy Mixpanel if all else failed.

MixpanelMixpanel CEO Suhail Doshi.

“Nobody is smart enough to recognize what is going to happen,” the banker shrugged, Doshi recalls.

What Doshi took away was that he couldn’t plan for instant smash success, or for an acquisition, either. He had to get Mixpanel’s spending under control, “bunkering in” for the long term and assuming that no reasonable option would exist in the short term.

JR Rivers, CEO of Cumulus Networks, says that there’s no reason for companies to be so focused on the idea of growth at all costs. It gives your financials a bump whenever you hit a big growth milestone, but it doesn’t account for the cash it takes to get there. And so, all the “celebrations” around huge funding rounds for unprofitable companies just don’t make sense to him, he says.

“Now, being super small in early days, when you’re trying to find your way, it makes sense to live in a deficit,” Rivers says. “But if you look at the celebration that’s occurred in the last couple of years, it doesn’t line up with my philosophy.”

Panel moderator Peter Levine, general partner at Andreessen Horowitz, thinks that this actually makes for better companies. If your primary concern is building a company that looks good to a would-be buyer, you’re probably neglecting other important aspects of the business.

“Whenever you build a company for [mergers and acquisitions], then guess what, it turns out to be a suboptimal company,” Levine says.