How startups should handle the downturn

The 2022 crisis is the third major tech downturn of the internet era, following the dot-com bubble and the Great Recession.

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 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:

  • Two years or more.
  • Between one and two years.
  • A year or less.

The corresponding strategy for each would be, respectively, “stay aggressive,” “ruthlessly prioritize” and “time to trim.”

Editor’s Note: TechCrunch+ has notes from an interview with the author of this letter, Mike Volpi — including the potentially good news it contains for many startups — coming shortly. The following letter was lightly edited and reformatted for our pages.

Great companies are born in difficult times

Great businesses have been built and have 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 it almost went out of business in its early days. Most recently, Uber enjoyed a similar rise during the Great Recession.

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 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?
  • Have you evaluated and prioritized your engineering projects and marketing programs?
  • What is your competition doing?

If you have two-plus years of runway, stay aggressive

The last few years have been a favorable time for founders looking to raise capital. Venture capital firms of different shapes and sizes deployed capital at an unprecedented pace, and as a result, many companies found themselves with healthy balance sheets representing years of operating runway.

Conventional wisdom states founders should “batten down the hatches and reduce spending to extend your runway.” However, this approach may compromise your momentum. Before blindly cutting spending, it’s important to be strategic and deliberate.

Pay close attention to how your customers behave. 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 compared to 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.

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 (kitchen, travel and apparel) and international markets. These new business lines more than offset losses in other areas.

If you have less than two years of runway, prioritize ruthlessly

Keep growing but grow efficiently. Efficiency can be thought of differently depending on the functions within a business. In go-to-market 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, doing so can be very efficient from the perspective of customer acquisition costs. But some products are just not well suited for such a GTM approach. You could 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 thoughtful prioritization of projects is key. 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 becoming mainstream during the pandemic, most organizations are equipped to manage engineering teams in locations in the U.S. outside of Northern California or in other countries.

In order to be ruthless about efficiency, leaders must instrument their business around metrics. For example, in marketing, you might choose to measure incremental spend (or reduction) in lead generation rather than actual leads generated. In sales, you might measure the relative cost of a sales team by customer segment rather than the ARR generated from that segment.

One question comes up often: “If offered, should I raise capital opportunistically to extend from two years to three or more?” Generally, 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 valuation.

If you have a year or less of runway, it’s time to trim

Unfortunately, these companies face the biggest challenges in such times. You may have to trim. You might have to think of significantly cutting costs across a variety of areas — products, R&D and sales. Focus on efficiency everywhere you can and communicate your strategy to your employees. But remember, it’s best not to leave this to the last minute; the less time you have, the fewer the options available to you.

During this time, you may have to decide 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 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.

Many companies and individuals in the tech community are facing unprecedented and difficult times. But our industry has seen this before and come out the other side brighter. 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.