Welcoming the public market declines

US stock markets have taken a hard hit in the past week. Despite yesterday’s gains, the S&P 500, Dow 30, and Nasdaq are each down close to 10% over the last week. Tech stocks have also experienced large drops across the board.

The declines have been covered at length elsewhere so I’m not going to describe them in more detail here. Instead, I am going to write about why I believe that startups are lucky that we’re seeing these declines now rather than from potentially higher levels later. This assumes that what we’re seeing now is a structural shift in the market’s attitude towards risk rather than a short-term correction in a market that will once again resume its long-term rise very soon.

I had written about the froth in private market valuations in earlier posts here and here. Although the effect was more pronounced for late stage companies, seed and early stage valuations were also very often higher than what could be justified by company fundamentals. As a result, I welcome the drops that we’re seeing now. Although they create short term pain, they’re necessary for companies to develop sustainable growth plans with a path to profitability. Outside cash won’t always be readily available, and a company’s goal is to build a business that can generate this cash internally from its operations. It was all too easy to forget the latter requirement in the last few years.

And here’s why I think that startups are lucky to be seeing these public market declines now rather than from potentially higher levels later. Declines in public markets which serve as exit routes for private market companies will cause declines in private market valuations. And these private market declines will be much more manageable if they occur from the current level than if they were to occur from a higher level in the future.

It’s similar to falling from a building. You’re much more likely to survive if you fall from the second floor than the fourth floor.

Hopefully, by falling from the second floor now rather than the fourth floor in the future, less startups will die and more startups will have injuries that they can recover from. This is a good thing.