Silicon Valley’s Undertaker: ‘We’re Anticipating a Major Fallout’

As longtime readers know, we occasionally like to check in with Sherwood Partners in Palo Alto, long known to industry insiders as “the undertaker” because its primary role is to efficiently shutter companies.

Sherwood made a killing in the aftermath of the Internet bubble, closing down roughly 180 startups. At the time, the company itself went through dramatic expansion and subsequent downsizing. But all along, insists its inimitable cofounder Marty Pichinson, Sherwood has had plenty of startups to wind down.

“Our largest year was 2000, but equal to that was 2010, and between 2001 and 2010 there was just a 3 percent variance,” Pichinson says. “I’ve got guys with me 15 years.”

Given the market’s zigs and zags, along with talk of the coming “winter,” I thought it made sense to ask what he’s seeing right now. Our conversation has been edited for length.

You’re going on an African Safari soon. Does that mean business is slow right now?

We are busy as beavers. We’re doing two to four deals a week. I’m finding that fundings themselves have created a unique problem. An ever-smaller group of companies is attracting all the financing, including through the IPO market, and once a company gets such a huge concentration of cash, those without as much begin drifting away.

What kinds of companies are you winding down right now?

We’re starting to close down social networks, startups in video distribution, clean tech companies. We’re also closing down a retail site. For companies selling merchandise, it’s a pretty volatile market, and this company couldn’t get traction. Also, with retail sites, you have to hold inventory. You need a variety of sizes and widths and colors, because if you don’t have the right merchandise, you lose the customer, yet if you have too much merchandise, you have to discount it. Most people don’t understand retail. They understand the concept. But it’s a very complicated business.

How big are these companies, generally? Where are they on the financing spectrum?

We have lots of Series A deals, along with Series C, D, and E. We’re seeing companies with Series B financing less. Once it gets to the Series B round, you see people really trying to pull that coach through to the next depot. It’s a fascinating phenomenon. But once you get to C and D and E, you realize, sh*t happens. What can you do? It’s usually the case that a competitor got more market share first, or that when the company needs that ‘oompa’ money, it’s just not available. Another big problem with later-stage companies is that there are just fewer customers [to buy them or to sell to]. Remember when there were seven cell phone companies? Now there’s what, three?

In terms of the younger companies, what do you have to unwind exactly? What sorts of assets do they have to sell off?

Things have definitely changed. I remember in 1999, 2000, I would sell a used server for $35,000 and I had a line of people wanting it. Today, a server is $5,000 and you can get an okay server for less than $2,000. [In the meantime], we’ve probably become one of the largest sellers of [intellectual property] in the country. We sell tons of IP, and as you know, the IP wars have started, so we play with the big guys, the little guys, and the in-between guys.  During the last bubble, there weren’t as many patents. It was more ideas and URLs. So the business has matured.

Who are the most active buyers?

Believe it or not, it’s usually competitors in the same space that just want to lock up that additional technology. It’s the companies doing between $15 million and $50 million in revenue that are mostly knocking on our door. The bigger players are interested, but they move slow, and we have a deteriorating asset and an obligation to the creditor [to get some money out of it], so we don’t have months to figure it out.

We’re starting to hear about perks again, like an in-office tree house. Are you seeing excess again at the companies you are helping to close?

No, we’re not seeing that at all, though I know it’s out there. I think we’ll start seeing that between the second and fourth quarters of next year, when we’re anticipating a major fallout of social networks, along with clean tech. But furniture, for example, hasn’t been a big expenditure [in recent years]. We’re not seeing the large warehouse spaces anymore. The seed and early-stage investors haven’t given these startups millions upon millions of dollars. For the most part, no one is giving big bucks to people anymore for crazy things.

And you’re working with both angels and VCs?

Oh, yes, we work with everyone, because corporate attorneys are essentially secretaries to the companies. There is probably no industry outside of the startup industry that begins companies in the most proper, prim way possible, including ensuring there are good law firms involved and the right accounting firms. That way, when the window of opportunity opens [for a potential exit], everyone is ready to go.

Why are you expecting an uptick in business next year?

First, consider that over the last 10 years, something like 22,000 companies that have been funded. That’s 2,200 a year. What’s happening is that in the seventh year of the venture life cycle, you better know who you’ll double down on or drop off the boat. Do you think there will be more than 400 exit events a year, meaning IPOs, mergers, and so forth? Maybe. There definitely won’t be 600, though. That leaves 1,500 companies, give or take, that will die. The world can only absorb so much.

What about market volatility? Do you anticipate it will play a role in how much business you’ll see?

Nah. I don’t think that affects us. VC is VC. Look, I took my money out of the market a year ago. Did I miss some upside? Yes, but until people go back to work, I don’t see the market changing. It’s nice that Apple and Cisco are making money, but there are a lot of people out of work in Chicago.

What I do see are fewer customers and fewer acquirers. Facebook can do an IPO whenever it wants, maybe Groupon, too. But not everyone will be able to do an IPO right now. People are running scared.

For us out here, life is exciting. You no longer have to go out to the store every day. You can stream movies on Netflix. I just bought a new, 60-inch Sharp TV at Costco for just $1,800. And everything is changing with Pandora and iTunes and the iPad. When I travel now, I take nothing with me but my iPad.

But how much new stuff can Ford put in their cars? How many new social networks are you going to get involved in? If someone new comes along, someone else has to give up their space.

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