The earlier a startup is, the more buffered it’s from the ups and downs of public markets. But buffered doesn’t mean insulated. At Tau we focus especially on late seed and see it being affected by economic downturn; what used to take months now takes weeks if not days. It’s not necessarily a bad thing, in fact a challenge does present an opportunity. This article provides a framework for entrepreneurs to not only survive but thrive in a bear market, continuing a past dialogue from these other posts:
Mar 23, 2020: Crisis? 3 Ways VCs Adapt
May 11, 2020: Why Found A Startup During A Crisis? 4 Key Reasons
1) Fundraising – Is often the most obvious immediate effect of an economic downturn:
i) Amount – Expect lower round sizes. It’s not that investors suddenly run out of money, it’s because they go into a bit of hibernation. First, they save more of their funds for existing portfolio companies. Second, they anticipate a harder time raising their own funds because LPs are affected by the market.
ii) Valuation – Expect lower valuations. Valuations had increased by 40% in the last 2 years and as of writing this article have now essentially come down.
iii) Runway – At Tau we advise startups to generally have a runway for at least 18 months, but in leaner times focus on 24 months. This can be accomplished through many ways: decrease burn, increase revenues, raise equity, raise debt.
What should an entrepreneur do? It’s to factor these three components into all major decisions. After all, half of a CEO’s job is to make sure there is enough money, the other half is to hire people to spend it.
2) Hiring – Speaking of hiring, a downturn generally means the world hits brakes on compensation and recruiting. At Tau we believe it’s exactly the time for startups to capitalize on available talent. Many in fact argue this is when the best companies have been created – Microsoft and EA were founded in a recession, while a downturn was crucial in the story of Apple, Google, Salesforce, Facebook, Netflix and AirBnB. Want to hire but don’t have the cash? Many tools are at your disposal to incentivize employees, including offering more equity relative to salary.
3) Traction – If the overall economic engine slows down then getting customers to pay also does. Sales cycles that are 9 to 18 months become 12 to 24 months. Pilots that were supposed to be $500K become $400K. Contracts that would be renewed get delayed or canceled altogether. A time-tested solution is to change the internal mix of projects, perhaps more emphasis on those generating short-term revenue. A bolder approach is to accelerate the development of projects that would have bigger yields, even if they are riskier and / or more time-consuming. The right answer is specific to each company’s journey, the key is for an entrepreneur to have that conversation internally and also with his / her investors.
4) Exits – Is arguably the area that is most affected long-term by a downturn. If further fundraising is not a viable option and you have enough cash in the bank for at least 6 months, then put much more energy into an M&A process right now. If you are truly starting from scratch then a good banker who can open up doors is practically a must; they will usually take 5-10% of the sale prices. The easiest paths are courting a competitor or a customer since they already have a relationship with you. Arguably the second best option to test out quickly is asking your investors to check in with their other portfolio companies. A sale doesn’t mean dissolution, after all maybe what makes sense is to do a partial sale and refocus the remaining business. If selling is not a viable option altogether then it’s a more difficult conversation around pivoting the business, recapping, or even shutting down. If the bear market is going to eat you for lunch then salvaging some value is still a victory.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.