Interest rates have plateaued at levels not seen in recent history, which means that startups and tech companies are likely operating in a business climate not seen recently: an elevated but stable interest rate environment. This rise in interest rates has primarily influenced the shift to a more challenging environment for startups over the past 18 months, impacting everything from VC/fundraising to top-line growth to daily operating costs. As we step into 2024, the question on everyone’s mind regarding interest rates is, How do we plan for the future? I recommend that companies focus on three things: (1) the return on investment (ROI) of innovation, (2) capital conservation, and (3) risk management.
Return on investment
In terms of emphasizing the ROI of innovation, growth is still paramount at tech companies, but they need to grow in a way that brings an ROI and ultimately yields cash flows. In their early years, most tech companies are financed by venture capital, specifically designed to fund enterprises that lose money initially, taking significant risks (and big losses) to ultimately realize outsize profits.
The interest rate trajectory has been more stable over the past few months.
This affair is still true today, and high growth is the primary indicator of a young company’s ability to eventually generate significant future cash flows. This is true in all interest rate environments. However, the nuance is that with higher rates, the value of future cash flows is discounted at a higher rate (worth less today), so the relative value of huge outsized future returns versus current losses is more muted.
The interest rate trajectory has been more stable over the past few months. At this elevated but not astronomical level, tech leaders should continue to emphasize investment and projects that will drive growth. Still, they should do so with more visibility — and tighter timelines to realize the benefits. Specifically, this means funding projects (often in product builds) with clear — at minimum — medium-term (six to 18 months) paths to increasing revenue and/or lowering costs.
This does not mean ignoring projects that impact only user experience; those are always relevant, but it means, for example, being clear on how that user experience improvement will drive product engagement that, in turn, moves a desirable metric (which in turn likely impacts revenue or cost). Explicitly state that metric movement and hold the project leaders accountable for it.
Breaking complex trade-offs around investment and return is becoming more accessible by leveraging recent advances in generative AI. As companies plan for 2024, they should leverage productivity-enhancing software and vendors using the advances in generative AI to stretch their investment dollars further. AI-infused coding copilots, meeting summary features, productivity-software enhancements, and expense management tools are all ways companies can enhance the return on their personnel investment with minimal negative repercussions.
Capital conservation
A second critical goal for 2024 is to continue to preserve capital. Data at Brex shows that for the last 18 months, startups have been very effective at extending their runways by growing revenue faster than expenses and cutting costs. More of this will be required in 2024, as neither the IPO market nor the venture capital fundraising environment has improved materially. What worked in the past, including careful headcount planning and finding SaaS efficiencies, will continue to work.
However, recently we’ve seen mixed performances of the late Q3 and Q4 IPOs (Instacart, Klaviyo, Arm, Birkenstock), the corporate drama around Silicon Valley’s most high-profile private company OpenAI, and giant unicorns shutting down, including Convoy and Olive AI. This combination of events will likely continue to constrain fundraising activity, especially in later-stage companies. Companies cannot count on new or existing investors to continue to fund money-losing enterprises without clear ROI and financial viability. Cash runway continues to be paramount, and capital conservation — in the form of careful spending — is the simplest way to maintain it.
Risk management
Lastly, risk management is critical, especially regarding bank and vendor relationships. As we saw with the collapse of Silicon Valley Bank in March 2023, bank balance sheets are severely impacted by the rise in interest rates, as the value of their existing bonds and loans is impaired with higher rates. This issue is not unique to Silicon Valley Bank’s failure or the others that followed last March. Hence, companies must carefully consider the structure of their bank accounts, maximize FDIC insurance, and minimize exposure to any one bank. Failure to do so could mean not having access to your company’s cash for periods, which could severely impact your operations.
One often overlooked and related point is broader vendor risk beyond just banks. As discussed above, with less funding in the market, companies are shutting down and paring back, especially in the tech sector, which has been among the most affected by higher interest rates. Tech companies often use other tech companies as vendors. As a result, vendor shutdowns — and potential acquisitions that could be equally disruptive to services — are risks that leaders need to consider. If you have critical services (e.g., software, banking, facilities) provided by companies that are at risk of shutting down, your operations are at risk.
Plastiq’s recent bankruptcy was an example, as it heavily relied on Silicon Valley Bank for money movement, and the bank’s shutdown impacted Plastiq’s operations so severely that the company ultimately filed for bankruptcy.
While interest rates have sobered the environment in the technology industry, the promise of innovation endures. There is so much to be excited about, and the companies that can appropriately allocate capital for innovation that has a high return on investment, protect their cash balances, and manage risk will be set up well to capitalize on the business opportunities over the long-term, regardless of the interest rate. Next year will likely be difficult but manageable, and we all should be excited to enter it, with appropriate caution.