Chris Farmer could sense the tech downturn was coming from a mile away.
Having previously run a company during the dot-com boom, he had a feeling that sky-high valuations and massive funding rounds would eventually collapse. So Farmer, CEO of VC firm SignalFire, made changes to protect his firm: investing earlier and actually having a hand in guiding his portfolio companies in executing strategy.
Protocol talked with Farmer about investing to prepare for economic volatility, the future of VC and running SignalFire like a tech company, rather than as a venture firm.
This interview was edited for brevity and clarity.
Tell me about SignalFire’s main investment verticals.
At the end of the day, we are talent-driven investors. We build large-scale systems as a firm to track the best entrepreneurs and talents and engineers that are moving around. To some degree that dictates where we go. Now that said, we also have areas that we focus on heavily where we see a huge opportunity, and obviously the macro environment impacts that as well.
We do a lot of health tech, which tends to do very well in economically volatile times; a lot of SaaS; a lot of fintech, but we tend to do stuff without balance sheet risk, where you're not lending, [because] that tends to do very poorly in economic recessions.
If I had to choose one thesis, it’s that we're a super data-driven firm. Half the team have degrees and experience in AI or machine learning.
I noticed that SignalFire’s built a team over the years with some experienced tech talent. How’d you manage to recruit that kind of talent?
We are built like an operating company, unlike a venture partnership. We are structured like a tech company, much more than any other venture firm. I'm the CEO; we have a CTO; a talent officer, that’s [Tawni Nazario-Cranz]; we have a head of go-to-market, that’s Jim Stoneham; we have an engineering and data science team.
I think that was what ultimately attracted them: They saw that what we were doing was pioneering something very different than what they were seeing from other venture firms. We allow them to really be an operator more than an investor, but to do it across a whole portfolio of companies. If you like advising early-stage companies, it's the ultimate sandbox from that standpoint.
How is the tech downturn affecting your firm and portfolio?
None of us are immune from the economic downturn and, you know, I've tried to stay off VC Twitter. I ran a company from 2001 to 2004 after the dot-com bust. I’m always sort of waiting for the next shoe to drop.
I started getting very worried three or four years ago; I thought, “This is not sustainable.” We were 12 years into an economic growth period. It was already the longest in history, you can’t imagine there's going to be another three to five years on top of it. I'm just like, “OK, this party is going to end.” So we shifted earlier. We traded valuation risk for execution and technology risks. We shifted our breakout fund, which was historically series B to series A, and we shifted our seed fund to pre-seed and early seed. So we're not sitting on a bunch of stuff we way overpaid for.
Have you noticed any industries that are more or less resilient than others?
I would say cybersecurity has held up much better than a lot of other sectors, and health tech held up relatively well. Now, some of the valuations got sort of kind of crazy in both of those categories. But you're not going to rip out your cyber products. The deeper in the tech stack you are, the more resilient.
But anything hardware, heavy R&D, where there's no revenue or a path to profitability, those sectors just get obliterated during economic downturns. The other one is if you don't have a fast payback on your customer acquisition, so a lot of direct-to-consumer companies. You're seeing a lot of people pull back their marketing spend, and if you don't have really amazing recurring subscriptions and retention, etc., that's just brutal.
What makes SignalFire want to invest in certain startups? What do you look for?
It starts almost entirely around talent and interesting market chance, asking “is there a tectonic shift happening?” So part of our health tech thesis is that, while it has been a pretty hard sector — regulatory risks, hospital bills, razor-thin margins, people's lives being on the line — COVID blew the doors off the the hesitancy of telemedicine, the consumerization of health care, because they had no choice. And I think a lot of people don't want to go back. That creates a huge opportunity to innovate. So we look for those sorts of tectonic shifts.
We also look for super interesting founders. Sometimes there’s a market you never would have thought of, and you're just backing an amazing entrepreneur.
With a potential recession looming, what does the future look like for the VC investing landscape as a whole?
I think we saw a huge generation of people dabbling in venture capital, some of them very seriously and some of them as side hustles or weekend funds. I don't mean that pejoratively, but, you know, they have a day job. Obviously some of those people will have used that to just completely fall in love with venture and commit their life and do an amazing job at it. But I would say probably 75% of the people will be like, “Wow, this is a lot more work and it takes a lot more of my time than I thought.”
I think there are a lot of angels that will take a breather. There's a lot of funds that saw it as a great way to make extra money on the side that weren't as serious or committed. The more-opportunistic ones, those will go away. And the prospect of no help may not sound as good to a lot of entrepreneurs as it once did, because you're not going to get five investors at six-month intervals anymore. You may have to go several years before your next funding round. So you need people who are going to be with you in the trenches.