A cold winter for startups, but there's a clear road ahead
Previous downturns have been worse, and there's a growing mountain of capital waiting to jump back into the market
There’s no escaping the headlines; this is a bad news economy. The fallout from the pandemic, shaky supply chains, slumping stocks, and red-hot inflation are contributing to a perfect storm of uncertainty that could last for years.
It’s inevitable that startups are feeling the impact as well. Their struggle for both capital and customers - difficult in the best of times - will get even harder as investors and consumers tighten the purse strings. It’s a grim outlook. The worst in a while.
However, it’s not unprecedented. It’s not even that unusual. The dotcom bust in 2001 and the Great Recession in 2009 suggest there’s a crisis roughly every 10 years, and the current one may even be slightly overdue.
Although we’re entering a once-in-a-decade downturn and it won’t be easy, there’s an important bit of context for these times that is worth remembering as investors and startups position themselves for the challenges ahead.
We’ve been here before
In 2002, at the worst point of the dotcom crash, the share of US startups surviving for at least one year was 75.7%, which wasn’t much less than the 80.1% survival rate at the peak of the bubble in 1999.
A similar pattern unfolded a decade later, when the share of startups surviving after one year was 80% at the pre-recession peak in 2006, but a still respectable 75.3% during the nadir of the financial crisis in 2009.
It’s a useful reminder that while these crises are incredibly difficult times, they are survivable. And for the savviest startups and investors, the hard times may actually turn out to be less of a challenge, and more of an opportunity.
Let’s unpack some of these challenges, and then explore how they provide startups with opportunities to strengthen operations, clarify goals, and ultimately pull away from competitors who fail to do either.
Investors are getting cautious and this is having an immediate impact on valuations. Companies like Stripe, Klarna, BlockFi and Instacart have seen their valuations cut by as much as 67% this year while the number of successful IPOs in the US has hit a 13-year low.
Some VCs will fail to raise capital and others will move to the sidelines and wait for the dust to settle. It’s a dispiriting outlook for startup founders to see funding disappear and valuations fall.
As we have seen with the bounceback from downturns in 2001 and 2009 however, this capital won’t sit on the sidelines for long. Elon Musk said in May he sees the current slump lasting 12 to 18 months while the Fed’s aggressive rate hikes suggest they are targeting a severe but short contraction.
And when economic conditions do improve, there will be no shortage of capital for those startups that emerge leaner and stronger. VCs have raised $150.9 billion in the first three quarters of 2022, up from $147.2 billion in all of last year.
This is a lot of dry powder waiting to re-enter the startup scene.
Tougher questions create better solutions
After a frenzy of investing last year when some VCs were making deals within days and hours without even a whisper of due diligence, it’s a very different market today. Those inexperienced VCs are gone and the smart investors who remain are asking tougher questions.
They are calling customers, talking to former employees, scrutinizing every revenue stream, counting expenses, and picking over spreadsheets in a way that will challenge even the most squared-away founders.
This laser-like focus on the details is something that founders should welcome. It’s an opportunity to cull unnecessary expenses line by line and re-negotiate better terms with vendors who will be more willing to accept discounts and longer repayment periods.
It’s time to speed-up big decisions so they are made in under 30 days instead of dragging over 60; and an opportunity to cut, cut, cut costs to create a leaner operation with a longer runway.
Firing and hiring
Cutting costs means letting some people go. After spending so much time hiring great people and building a tight-knit community, it can be incredibly difficult to look an employee in the eye and tell them it’s over. It means losing their skills and reducing the company’s capabilities, and it can have a devastating ripple effect on the morale of those who remain.
As hard as firing people will be, it forces founders to take a hard look at which employees are contributing a ton of value and those who aren’t. A very difficult decision today will inevitably hurt people you love, but it will potentially save the company you created.
Layoffs are a dark cloud hanging over everyone, but there is a silver lining as well. With companies like Meta, Netflix and Shopify letting 42,000 tech workers go so far this year, there’s suddenly a window of opportunity for startups to hire talent that would normally be well out of their reach. Decide quickly. Choose wisely.
Every economic indicator is pointing to a sharp correction. This will cause some VCs to hit pause on investing. Others will focus on prepared founders who are using the downturn as an opportunity to pull away from their less-prepared competition.
Tough times have happened before. They will happen again. The smart founders and investors will do what it takes to survive, and they will be in the best position to thrive when the markets inevitably recover.