When the market sours, the business underneath is what remains

August 2011 put the line to a fresh test. After Standard & Poor’s cut the credit rating of the United States on the fifth of the month, share prices fell hard for several weeks, and a number of technology companies that had been preparing to list pushed their offerings back, Groupon among them. The same spring LinkedIn had doubled on its first day of trading. Within three months the mood had swung from one extreme to the other, while the companies involved had changed very little.

Fred Wilson co-founded Union Square Ventures in New York and writes about venture investing every day on his blog. The sentence circulates under his name, though the particular post or talk it came from could not be traced. It fits a theme he returns to often: prices and investor appetite move on their own schedule, and a company’s actual performance moves on another.

The word “market” in the line means the financing and trading market. Read that way, the claim is strong. Amazon’s share price fell by more than ninety percent from its 1999 peak to its low in 2001, a collapse that looked like a verdict on the company. Sales kept rising through the whole period, and Amazon reported its first net profit in the last quarter of 2001. Anyone judging the business by its share price in those two years would have been badly misled; anyone judging it by its customers would not.

Read “market” as the customers, and the line turns false. Blockbuster was a good business by almost any measure for two decades, with stores in most American towns and a steady rental habit to serve. It filed for bankruptcy in September 2010 because the way people watched films at home had moved to the post and then to the internet. A good business tied to a market that disappears goes with it. Kodak’s film business is going through the same thing now.

There is also a narrower failure inside the financing reading. Good businesses that need capital up front can die in a closed market even when their economics are sound, simply because the money to reach the next stage is not available for a year. A hardware company with six months of cash and a financing round planned for a bad quarter is exposed, however good its product.

The practical advice sits in the gap between the two readings. Treat valuations, round sizes and the tone of the press as weather, and plan to outlast a stretch of bad weather with cash in the bank. Watch the customer market with much more care, because that is the one that can remove a business completely. The line is a comfort in a sell-off and a warning at the same time, depending on which market is moving.