We sent this letter to our investors last week, and in the spirit of thinking and learning in public, believe there might be some value in sharing an anonymized version.
We hope you and your families are healthy and safe. When we last wrote to you in April, it had only been six weeks since most of the country went into lockdown. Almost four months later, a lot has changed, and it very much feels like we are in the early days of a larger transformation.
As we look at the broader economic picture, confounding feels like an apt description. Unemployment numbers have improved from April’s peak, but are still near record levels, and the number of new cases spiking in late-June makes that progress feel tenuous at best. The amount of “permanently” unemployed (people no longer searching for work) has increased ~50%. Public markets have remained resilient, as trillions in stimulus dollars overshadowed a steady stream of alarming economic numbers. Tech stocks, in particular have soared, aided by the quasi-forced adoption of digital alternatives to many of our everyday activities. It's hard to recall a time when a 32.9% annualized GDP contraction coincided with a hot IPO market, but here we are. Despite some troubling numbers, there are reasons to be hopeful. Halting progress has been made towards a vaccine, consumer spending has improved for two consecutive months, and some parts of the country have done an effective job flattening the curve. While we may be heading in the right direction, we are far from through the proverbial woods.
As we inexorably progress towards recovery the exact ramifications to our economy will be impossible to predict. Attempts to do so may result in seemingly objective analyses, but these are typically just arbitrary numbers slapped onto subjective judgments. We avoid this type of work and suggest you do the same. Wise investing doesn't require prescience, but it does require seeing the present clearly. This includes recognizing both what we do and do not know. What we do know is companies that quickly adjust to new normals will be better positioned than those that move slowly. We do know that a tectonic shift in how companies are forced to operate provides a massive opportunity for investors in young companies. We do know that our economy isn’t some exogenous thing that exists outside of the businesses which make it up. With this knowledge we have focused on defining a set of priorities and questions to help us better understand what is changing at the business level. And these insights have been key to helping us more efficiently navigate the current landscape.
In the NFL, there is an acronym that's often used in preparation ahead of games. “WIN” which stands for What's Important Now. NFL teams break the season down by week. Each week has its own opponent, and preparation for each opponent is its own standalone process. A key part of this process is establishing a set of unique priorities for the upcoming game. These priorities can vary widely from week to week. For example, the top priority one week might be limiting the opponent's yards per carry, while the following week's focus could be maximizing receptions for our star receiver. Finding the right priorities each week is a function of study, both of the opponent you face, and your own past performance. It sounds tedious, but in both the NFL and investing, where talent parity is high, unique insights are what differentiate the best from the rest. WIN is a reminder to focus on the unique priorities established each week. WIN is not about focusing on long-term goals. If the weekly priorities were "win the Superbowl" or "be the best defense" the season probably wouldn't go well. WIN is about focusing on near-term priorities, on the actions we need to take today to ensure we’re on track to achieve the long-term goals.
If goals are the destinations we hope to visit, WIN priorities act like dynamic routing in a GPS app, helping us make small course corrections to avoid accidents and traffic jams. Our goals and core values at El Cap have not changed since inception, nor have our investing frameworks. What has changed is the world we operate in, with the pandemic causing what equates to an economic traffic jam. Finding the proper off-ramps and frontage roads to speed up our journey is what WIN priorities are all about. As investors, the practical application of these priorities is a set of questions that we asked both our current portfolio companies and potential new investments.
Like dynamic routing, What’s Important Now thinking is only useful if it remains malleable to adjust to changing conditions. This quarter there were three areas we believe demanded additional focus:
(1) B2B sales
(2) Remote work
The WIN questions we developed around each of these areas helped us more efficiently evaluate several potential investments that at first glance appeared to be attractive, but upon deeper inspection did not hold water. Answering these questions is vital to understanding the durability of a business in the current environment. Not having answers to these questions helps us quickly arrive at a pass.
B2B sales: The pandemic has been a tremendous challenge for most B2B sales processes. Budgets tightened, prolonging in-process sales cycles or halting them altogether. Lead generation became more challenging as conferences, trade-shows, and networking events disappeared, or existed only as watered-down versions online. Justification for purchase has both narrowed in scope and shifted in focus, with businesses prioritizing cost savings over growth. This has raised the bar for new product purchasing. To gain traction new products and services need to demonstrate immediate value to customers. These changes have forced sales teams to reframe value propositions and get creative around deal structures.
WIN questions we’re asking about B2B sales:
(a) Can the business quantify what has happened to their sales process? Can they describe the impact on conversion? Can they articulate the challenges they're facing in generating new leads? What are the proposed adjustments?
(b) Does the product deliver measurable value to the buyer in the first year of purchase? Difficulty in defining the value-add is highly correlated to difficulty in getting a sale approved.
Remote work: The massive shift of workers staying at home has happened at a scale akin to the migration of workers into factories during the industrial revolution, and the change in workplace dynamics has introduced real challenges. As the surge of adrenaline that buoyed operators in the early days of the pandemic begins to dissipate, CEOs are forced to grapple with the long-term prospect of operating remote-first organizations. Parents working from home are adjusting to being teachers and playdates for their children, while also trying to fulfill their professional obligations. Companies are also struggling to facilitate and prioritize unstructured team building across the organization, as no one has found a great way to replace the proverbial watercooler.
WIN questions we’re asking about remote work:
(a) What has been the impact of being forced to operate remotely? What are the changes to workflows and communication practices that have been made to ensure you're working efficiently?
(b) How have you addressed the culture vacuum created by the lack of normal employee interaction?
Hiring: Migration out of major metros has been a growing trend for years. People are leaving in search of a lower cost of living, more space, better weather, and to be closer to family. COVID has accelerated these migration trends. As people relocate across the country, in hopes of working remotely or only going into an office a few times a week/month/year, it’s only natural to imagine where new hubs of innovation will be created. Some of these will exist in cities, while others might exist entirely online. The massive forced adoption of remote work over the past four months has normalized the practice for a large portion of the labor pool. These changes present an opportunity for businesses that lean in and design their hiring practices to attract top talent through this channel.
WIN questions we’re asking about hiring:
(a) How have you changed your recruiting practices to cast a wider net for potential new hires? Have you considered how hiring employees in new cities might impact your budget? How have you adjusted your process for virtual interviews?
(b) What have you done to on-board remote hires efficiently? How will you cultivate a strong culture across a distributed team?
Investors are not immune from the need to ask difficult questions about the status quo. Those who are intentional about embracing flexibility and providing optionality to their company partners will be best positioned to succeed going forward. Established firms that are unwilling to or unable to adapt will struggle to transform their workflow, perspective, and brand. This is an opportunity for newer and more nimble firms.
We are excited about what the future holds but are not naive about the challenges ahead. During this time of transition and change, we have been settling into the new normal as we commemorate moving to LA one year ago in August. Hours spent with one another on Zoom. Weekend bike rides with masks on. Building and improving a workflow that enables asynchronous productivity by leveraging tools like Notion, Discord, Airtable, and ToDoist. We believe that we need to push ourselves in the same way we push our portfolio companies, to improve our processes, and find ways to be more efficient, while still creating the opportunity for unstructured conversation. We believe this is often where our best insights are born, so it is important to prioritize ways to create space for these conversations. Since we last wrote to you directly, we both have been writing more publicly. We encourage you to visit our blog, browse what we’re reading, and explore the rest of our newly designed website. We’re excited to hear what you think. As always, we are grateful for your continued trust and support. We look forward to speaking directly with each of you soon.
Stew & Kunal