published
September 13, 2022

How Startups Should Handle the Downturn

By
GEORGE FLANAGAN
published
GEORGE FLANAGAN

How Startups Should Handle the Downturn

By
GEORGE FLANAGAN
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The 2022 crisis represents the third major tech downturn in the Internet era following the Dot-com Bubble and the Great Financial Crisis.

Many experts are dispensing advice to founders on how to weather this storm. While this advice is broadly helpful, we must consider that it’s been approximately 14 years since the last major correction and increasingly few in our industry have actively gone through a full economic cycle. Therefore, it is important to remember that good advice is tailored, specific, and, more importantly, contextual.

Each company is unique and faces diverse circumstances. Does a downturn affect every company identically? No. Do some companies have more favorable balance sheets than others? Yes. Are some companies able to raise funds even in difficult circumstances? Absolutely.

The best advice for handling the downturn should be based on the length of your runway and the efficiency of your business. Runway falls into one of three categories: a) two years or more; b) between one and two years; c) a year or less. The corresponding strategy for each would be: a) “stay aggressive,” b) “ruthlessly prioritize,” and lastly, c) “time to trim.”

Great Companies Are Born in Difficult Times

Great businesses have been built and flourished through some of the most difficult times. Famously, Google raised capital in the aftermath of the Dot–com Bubble, grew through the downturn, and was able to distance itself from the competition. Salesforce, founded shortly before the 2001 crisis, survived the storm effectively, even though in the early days it almost went out of business. Most recently, Uber enjoyed a similar rise during the Financial Crisis.

Turbulence does require a different skill set from founders. Gone are the days of “grow at all costs.” Today’s environment requires subtle and precise control and management of the business. When navigated carefully, these periods can truly separate the wheat from the chaff.

The first step in navigating through stormy waters is to make a cold, hard assessment of your business:

How much cash runway do you have?

Do you have the proverbial product-market fit?

Is your growth strategy cash-efficient or not?

Have you evaluated and prioritized your engineering projects and marketing programs?

What is your competition doing?

If You Have Two or More Years of Runway – Stay Aggressive

The last few years have been a favorable time for founders to raise capital. Venture capital firms of different shapes and sizes have been deploying capital at an unprecedented pace. As a result, many companies found themselves with healthy balance sheets representing years of operating runway. The zeitgeist has been “batten down the hatches and reduce spending to extend your runway,” yet this approach may compromise the business momentum of your startup. Before blindly cutting spend, it’s important to be strategic and deliberate.

Pay close attention to the behavior of your customers. While the stock market has certainly corrected, many companies are still hitting or exceeding operating plans. This means that customers are still very happy to use and buy their products. If so, stay the course and keep executing your strategy. If customer behavior does change, a startup’s ability to course correct is lightning fast versus a large company. While we don’t have a crystal ball on the macroeconomy it’s not always sensible to preemptively correct, just because everyone is saying that a recession is coming.

If you don’t need capital—or your business can raise capital albeit at a higher cost—it may be time to be aggressive. Your competitors may be cautious, waiting for the storm to blow over. That’s an opportunity to take market share and establish a presence.

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Learn from Amazon. With full coffers (Amazon raised capital aggressively in its early years), the company was able to weather the 2000 recession and prosper by launching Amazon Marketplace, its platform for third-party sellers. It further expanded during and after the recession into new segments (kitchens, travel, and apparel) and international markets. These new business lines more than offset losses in other areas.

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If You Have Two Years or Less Runway – Ruthless Prioritization

Keep growing, but grow efficiently. Efficiency can be thought of differently depending on the functions within a business. In GTM functions, efficiency is all about the expense associated with acquiring and retaining a new customer. Some approaches are quite cost-effective. For example, if your product can be distributed in a self-serve manner, this can be very efficient from a CAC perspective. But some products are just not well suited for such a GTM approach. You can also look at channel partnerships that can deliver efficient customer acquisition, or you could raise quotas for your sales teams so that they have to deliver more customers for the same amount of compensation.

From a product and engineering view, the key is the thoughtful prioritization of projects. In any organization, there are “core” projects and experimental ideas that people are pursuing. If your runway is short, you may want to focus your resources on the programs that are yielding more short-term wins and are less speculative in nature. A robust product management process should reveal the payback cycle for projects.

Companies might also finally consider development centers in locations with lower costs than Silicon Valley. With remote work having mainstreamed during the pandemic, most organizations are equipped to manage engineering teams in locations in the U.S. outside Northern California or in other countries.

In order to be ruthless about efficiency, leaders must ultimately instrument their business around metrics. For example, in marketing, you might choose to measure incremental spend (or reduction) in lead gen vs actual leads generated. In sales, you might measure the relative cost of a sales team by customer segment versus the ARR generated in that segment. Each function can have a set of efficiency metrics by which they operate the business.

One question that comes up is: "If offered, should I raise capital opportunistically to extend from 2 years to 3+?” Generally, the answer should be “yes.” More capital will allow the company not just to survive longer, but to have the latitude to more comfortably execute its core strategy. This may mean taking capital at a flat valuation relative to the last round, but, what matters is a company’s public valuation, not its Series C one.

If You Have a Year or Less of Runway, Time to Trim

Unfortunately, these are the most challenged companies in difficult times. You may have to trim. Depending on each company, you might have to think of significantly cutting costs across a variety of areas – products and R&D, sales. Focus on efficiency everywhere you can. And communicate your strategy to your anxious employees. But remember, it’s always best not to leave this to the last minute; the less time you have the fewer the options that are available to you.

During this time, you may have to face the decision to raise money at a lower valuation. This is a tough message for the team, but keep in mind that the only valuation that matters is the one you get when you go public. Employees and the community, in general, will understand that we are traversing a downturn and businesses are not immune to that. If you don’t raise money, you will likely cede ground to competitors, or see new competitors that take away the opportunity that you’ve been pursuing. This may sound self-serving coming from an investor, but if you can live with an uncomfortable valuation, it will serve you well over the long haul.

For many companies and individuals in the tech community, we are facing unprecedented and difficult times. Yet, our industry has seen this before and has risen even more brightly. Times will change. The markets, and the competitive landscape, will look different in the not-too-distant future. The downturn can, in fact, be an opportunity for many companies. It’s an opportunity to understand the reality of our businesses. It’s an opportunity to re-prioritize and focus energies and resources. And, if thoughtfully navigated, it is a time when companies can distance themselves from their competitors. Being a private company is a huge advantage in these times. Being “small” is an advantage. As a startup, you have agility on your side. Imagine a different world, plan for it, and execute.

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