When the World Health Organization declared the COVID-19 outbreak a global health emergency at the end of January 2020, the startup world held its breath.
Many entrepreneurs prepared for a slowdown in funding, putting hiring and expansion plans on ice as they searched for ways to continue operating in a world that had been remade by the pandemic. TechCrunch and other tech publications ran stories and interviews with investors who noisily departed Silicon Valley, screening potential investments remotely as they set up shop in Austin, Miami and elsewhere to see how the situation played out.
But the pandemic did not quell investors’ appetites: Last year saw new records set for VC funding, unicorn creation and, in some cases, far less interest in due diligence than in years past.
Money is still available for founders who have storytelling skills and timely ideas, but investors have higher expectations now when it comes to revenue and growth, which could limit the kinds of startups that receive funding.
The question under consideration this week: How should founders prepare for an eventual retreat in startup valuations and investor interest?
In this column, Natasha Mascarenhas, Mary Ann Azevedo and Alex Wilhelm, the trio behind the Equity podcast, share their predictions about what’s in store for startup funding and due diligence in 2022:
Natasha Mascarenhas: ‘The Lean Startup’ has aged with an asterisk
When I first considered this question, I jumped to the obvious: Private startups, noting the public market slowdown, will refocus on their runway in preparation for a parallel cooldown in venture funding. But, as we’ve discussed previously, there is no shortage of venture capital in the markets today. Since all those mega-fund dollars need to go somewhere, I believe early-stage and mid-stage companies will be able to enjoy a capital-rich environment for a little longer than late-stage companies, giving them a bit of a bubble inside of a broader burst.
Is it idealistic to expect startups to build out leaner, less opulent operations in a growth-focused environment where so many enjoy lofty valuations and access to excess capital?
My thought is that, in response to a dip, we’ll see the re-emergence of lean startups that know how to stretch a dollar until it squeals. For context, Eric Ries’ “The Lean Startup” was written in response to the 2008 crisis and promoted the idea of testing, building and managing a startup all at the same time, prioritizing minimum viable products over a perfectly buttoned-up platform to create faster, nimbler organizations.
Today, the lean startup ages with an asterisk: Mega-funds have put funds into companies that now need mega-outcomes, bringing pressure and opportunity to the founders in charge. Venture-backed founders need to get more creative about how they spend and iterate, but opportunities are endless: Entrepreneurs could use contractors, part-time executives and asynchronous workers to slow hiring or push past how “impact” is traditionally defined. Vernacular will change: If becoming the “Amazon of X” isn’t the smartest target, founders could instead focus on building out key capabilities that will help them survive an even bigger slowdown. And contingency plans, if they aren’t already written out, will need to be codified.
Founders of private companies will likely need to focus more in the coming months, and isn’t that the point? The pandemic created extreme volatility: For example, many edtech companies experienced a massive influx of users overnight as parents and schools scrambled to adapt.
Those founders learned to iterate quickly amid chaos. Now, volatility is being tested yet again, albeit in ways other than up and to the right. The lean, green mindset doesn’t sound like a lack of ambition or a freeze. Instead, a reset sounds somewhat sane and realistic.
Alex Wilhelm: Money over bullshit
Nas once declared “money over bullshit,” and I cannot think of a better dictate for startups today.
Expanding on the American poet slightly, startups should conserve cash as much as possible for maximum runway and maneuverability. For startups that raised ahead of their fundamentals thanks to excitable investors, it’s a good moment to consider those funds perhaps the last that will be coming in, at least until they reach ARR-valuation parity – a target that gets harder to hit with each passing month as public-market revenue multiples contract. Startups are building in an uphill valuations climate today, and they should act like it.
What does that mean? That it may not be a bad time to pull the growth lever back a little and push the profitability lever forward a little more. As the market becomes more risk-off, demonstrating that the asset being built by a startup – namely its long-term positive cash flows – has the chance of self-sustenance will likely help companies raise.
But simply conserving cash through burn-limiting is only one part of the picture. I think that the market tightening that we’re seeing makes this a great time for startups to focus on a handful of core metrics and nothing else. Recall that Brex once opened a restaurant. That was, well, a little silly. Other startups have similarly odd but less public boondoggles afoot. If it doesn’t generate ARR or other high-margin revenues, it probably needs to go. And now is a time for choosing.
Money over bullshit, in other words. Regardless of whether the current downturn in market values is balloon deflation or bubble popping doesn’t matter to startups that can generate high-quality revenues and stay alive. Let’s see who makes it out the other side of today’s market changes with money in the bank and their staff still employed.
Mary Ann Azevedo: Don’t try to be all the things
Some of us have smelled a bubble amid this funding frenzy. And as public markets take a beating, I think investors should be more discriminating about where they aim their money cannons. So many startups are raising big bucks before they even have a viable product or customers or before they have gone to market. Let’s go back to the days where companies must prove more before raising huge rounds – more in the way of true innovation, customer traction and solid revenue gains. Attractive unit economics should count for more than a doubling of headcount or big plans for growth.
Fintechs in particular benefited as more people adopted digital payments and contactless transactions. This led to unicorns being born at a more rapid pace and companies accelerating product road maps, which in turn led to increased hiring. To fund all that, investors were more than happy to oblige, hoping to fund the next great thing. In particular, in cases where customer growth was impressive and growth metrics exceeded expectations, many startups found themselves raising preemptive, oversubscribed rounds. I can’t tell you how many founders told me they had to turn away investors.
Now, however, it’s time to take measured approaches rather than trying to be all the things.
Better to do one or a few things well than many things in a mediocre fashion. Some companies, in particular fintechs, seem to believe that being successful in one sector guarantees the same in other areas, feeding a grow-at-all-costs mentality.
As my colleagues mentioned, there needs to be a push toward profitability rather than galloping toward lofty goals with tons of new hires and inefficient spending habits. Take, for example, insurtech Root recently laying off 330 employees. That company went public in October 2020, has never turned a profit and is still — clearly — struggling. Meanwhile, Brazilian fintech Creditas is growing its revenue at an impressive rate, and while it’s not yet profitable, it’s also not rushing to exit.
Startups of today, take note. Slow and steady wins the race.