Tech is entering a downturn. After a 13 year bull market run, anywhere you look in the stock market these days, it’s mostly RED. The tech companies that have been stock market darlings, breaking new records, are struggling, many missing analysts expectations.
Rising inflation and interest rate hikes, growth in debt to GDP ratio, the war in the Ukraine (and global instability), increases in prices of energy, changing consumer habits to a post Covid-19 market, supply chain issues, etc, might be all contributing factors to the stock market (and tech in particular) declines. And the markets reacted to all of these.
Taking stock of where we are
The crypto market didn’t fare much better, losing a Trillion Dollars in value in the course of a week. Stablecoins like Terra/ Luna (a $40 billion market cap), which were supposed to be pegged to dollar and keep a steady value, collapsed to practically zero.
And in the private markets (i.e. venture capital and private equity) the VC index (by Refinitiv) shows a nearly 40% decline. That’s not to say that the declines have been written off already, but as mentioned in the ‘prisoners dilemma for growth stage’, it’s a matter of time until LPs ask to adjust the real value of their portfolios. Crossover funds, such as Tiger Global, Softbank Vision fund and Coatue, have experienced deep losses in their public portfolio, making them to reduce activity significantly. Tiger reported about $17 billion in losses, and Softbank lost approximately $20 billion, announcing it will reduce investments by 50-75% until March 2023.
What’s happening in the venture market right now?
While Q1 2022 looked normal, in venture, there’s a lagging effect in pricing, and deals that get announced in Q1 and even early Q2 2022 might have been signed in Q4 2021. Down rounds are coming.
- For many investors it’s not business as usual – and term sheets are getting pulled (normally a big no-no).
2. Round sizes will likely get smaller in the short term
3. The correction may last 1.5-2 years
Advice for startup founders (consolidated)
After the crazy year that was 2021 in venture capital, the tone has rapidly changed in May 2022. We’ve all seen it coming, but as of last week it’s clear that “the correction” is here.
As Gil points out in his latest newsletter, the situation is serious and to thrive companies must first survive:
Risk has returned in a big way, and many companies will not survive into 2023 or 2024. CEOs and founders need to look this harsh reality square in the eyes and start planning to ensure survival today. Every company’s situation is different and will require a different path. CEOs and founders who don’t grasp the potential severity of this downturn – who don’t acknowledge the very real possibility (however remote) of extreme left-tail downside risks – are setting themselves up to pursue far more fragile strategies than they might realize. To help focus this advice on something tangible, I’ll leave you with two questions:
Gil Dibner, Angular Ventures
1. What is your plan if half your current customers go bankrupt?
2. Do you have a plan for survival if you can not raise capital for the next two years?
This level of uncertainty can be very confusing for startup CEOs. So I wanted to go beyond the common sense advice of ‘spend less, earn more’, and share a bit more nuance from various VCs I respect.
Craft Ventures discussed the current downturn, what caused it, and how to survive it with its portfolio companies and made the recording public. Below is the video, but I’ll unpack it into five main points and combine the advice with A16Z’s framework for navigating downturn markets.
The key message from Craft: If your company needs to raise new funding within the next two years, conserving cash should trump growth.
1. Fundraising will get tougher
Startup founders should adjust expectations accordingly. David Sacks offers a few benchmarks on growth rates (revenue), gross margins, CAC payback and burn.
2. The 4 Startups states during a recession
Thomasz Tunguz from Redpoint Capital shared 4 scenarios that startups should be contemplating now depending on their sales efficiency and cash reserves. This is another way to look at the chart above by David Sacks:
Chewing Gravel: the startup hasn’t attained efficient commercial success yet and its bank account implies zero cash in less than 12 months. This is the hardest place to be. The company likely needs 1-2 quarters to develop a product and then 2 quarters to book business. Options include selling the business, raising an inside round, or all-out-sprint to save the business.
Time to Strategize: with a long runway but lacking product-market fit, the startup possesses the resources to scale. The north star should be efficiency. Minimize burn to lengthen runway and develop both the product and go-to-market efficiently.
Go Big or Go Profitable: customers want the product and the company has faith that bookings and churn won’t suffer in a downturn. You have a choice: Push to profitability; sacrifice growth for total control over your destiny. Or raise capital despite uncertain market to prioritize growth. Many of these businesses should find success in the fundraising market, but at different terms than a quarter ago.
The World is Your Oyster: spend a dollar and generate more than $0.70 in gross profit? Have plenty of cash? You’re in Position A, the top right of this quadrant. Full speed ahead.
Tom Tunguz, Redpoint Capital
3. Re-evaluate your valuation
The dip in the public markets gives an indication to the adjusted multiple companies can expect in today’s market. A16Z offers a quick formula for startups that have comparable publicly traded companies in their markets:
You can get a rough estimate for the change in your valuation by looking at leading public companies in your sector. If they’re down 60%, there’s a good chance you’re in a similar position. When looking at high growth public software companies, you’ll want to compare your ARR valuation multiple to their revenue valuation multiples because of its availability as a GAAP accounting metric.
Justin Kahl, David George, A16Z
Look at the bright side
But don’t despair: as Niko Bonatsos from General Catalyst points out, good companies will continue to get funded. There’s a lot of dry powder in the market (as funds raised record sized vehicles), but it comes with a new set of expectations on burn, growth and sales efficiency.
The old adage is still true: there’s never been a better time in history to launch a startup, and some of the best companies were built in downturns.
Additional reading (May 23, 2022):
- FirstRound Capital’s field guide for navigating this crisis
- Sequoia partner Ravi Gupta chimed-in on this ‘crucible moment’
- Lightspeed Venture Partners looks at the ‘bright side of a crisis’
- The now famous YC memo to startups: ‘plan for the worst’
- All In podcast: recession deep dive
I'm a former general partner at google ventures, head of Google for Entrepreneurs in Europe and founding head of Campus London, Google's first physical hub for startups.
I'm also the founder of Techbikers, a non-profit bringing together the startup ecosystem on cycling challenges in support of Room to Read. Since inception in 2012 we've built 11 schools and 50 libraries in the developing world.
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