In the Midst of an Economic Downturn, Start-up Founders Must Show their True Resilience
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In this post by Hessie Jones, two investors provide some salient advice to founders in times of uncertainty.
The investment frenzy we all witnessed in the fall of 2021 has suddenly come to a standstill. The bubble that has pervaded the VC ecosystem has finally burst and pundits are echoing blame on economic shocks like a pandemic that paused the supply chain and created high unemployment, and then followed by the invasion of Ukraine that further curtailed access to commodities, instigating rising food and fuel prices. The resulting inflation, the degrading consumer confidence and the higher cost of capital have made the once bullish investor pull back the reigns to re-evaluate their portfolio and spending strategy. The fallout of this free-for-all has seen start-ups downsize or close their doors, and brace for lower valuations in the hope of securing funding.
Many startup founders have asked us, the path to weathering this economic downturn. Neeraj Jain and Alaric Aloor convey their perspectives on the state of the market and what this means for valuations, resource allocation and raising money during this precarious period.
SLOWDOWNS MEAN RE-EVALUATING VALUATIONS
This current market has spurred the investment community into correcting prices that have suspended reality, in many cases. Inflated valuations, a seemingly endless well of funds and VC spending frenzy — all were predestined to end.
Founders have a responsibility to notice the signals of the changing economic environments. The prevailing economic downturn is signaling, in many cases, that founders cannot rely on business as usual, the way it has been over the last 12–24 months. Money is tighter, and investors are going to be more selective. However, if founders keep their eyes open, there is a momentous opportunity to flex business strategies and make prudent decisions about how to utilize and prioritize resources and come out on the other side.
Neeraj Jain, concurs that there will be less appetite for risk. The bloated valuations of the previous year will naturally mean there will be less competition from VCs trying to get into deals. His advice is the same whether it’s an up or down market,
Build a good company. Focus on the obvious things: revenue, costs, the team… what kind of IP do you have? Are you disrupting the market? I think one of the things that’s going to change is that money will be a little bit harder to get so now you are going to have to show more traction than before… it is really about the package: What actual value are you creating? And that needs to be real.
Jain adds this may be an opportune time to emphasize focus on increasing revenue:
Can you launch something a little earlier than you originally intended to? Can you put a premium version out there to increase your price?
Alaric Aloor, also recognizes these overblown valuations in the last few years. This downturn, to him is a “contraction” where money is no longer easy to attain. This period is a reckoning, and he believes the “cream will rise to the top.”
For a founder raising in this contracting economy, it is important when you approach potential funders to show them the sum of all your resources … talk about your intellectual capital, your technology, your brand value and financial assets you bringing to the table. And because there is no universal universally accepted formula to determine the valuation, we must start with the amount that you may want to exit with, factoring in the expected return on investment, the amount the founder invests, and the stock holding percentages that we want to negotiate with the founders to arrive at this this pre money valuation.
TIME FOR TIGHTENING BELTS AND BEING STRATEGIC ABOUT HOW RESOURCES ARE ALLOCATED
Slowdowns do not necessarily mean the investor will change their investment strategy. In fact, this may be a good time to Invest.
Jain does not see this time as changing the investment criteria.
This downturn was expected, and the economy will recover again. We should not panic as it is a normal course of our economic system. It also does not mean that VCs will not invest — instead, they may just look at deals with more scrutiny. But I will still look at the same criteria: whether it is traction, a good business plan and business model, the team — all those things are important to me. And the bar might be just a little bit higher to get funded… However, as an investor I do feel there may be more opportunities to see deals that may have been gobbled up before I had a chance to see them.
We have witnessed a tech market seeped in panic, layoffs, and shutdowns. Founders should lead through a crisis with empathy, responsibility and shed the “fire fast, hire fat” startup mentality.
For Aloor, who is also CEO of Archon Security, a 9-year-old company with 19 employees, human capital is the most important to a business, even during a downturn. He alludes to this “fire fast, hire fat” mentality:
When I talk to startups that I advise and they are looking to hire, I tell them to look for cultural fit. More importantly, are you going to be able to provide this person you are hiring with sustainable employment opportunities for growth over the long term. I am not talking to one year or two… but 5–10 years because as a founder and CEO, if that is your vision, you are going to be bringing on the right pieces to fit NOT because you received some funding. I advise against this because it is a bad model for growth without actually selling… So, when I advise startup founders about hiring, it is to avoid layoffs that we are now seeing across industry i.e., explosive hiring that companies have done with no consequence of looking at the long term. When you are a company that wants to be stable and in the long game you must have sustainable hiring processes and practices. Without that, the faster you go up, the faster you come down.
Jain emphasizes the importance of team:
They should involve the team and planning. How are we going to conserve cash? Involving the team in that is important. You do not want to create fear. You certainly do not want your good people to leave. They need to feel confident that you have the right plan.
MOVING PAST PANIC & UNCERTAINTY: INVESTORS ENCOURAGE WAYS TO STAND OUT
Many founders are asking, ‘How worried should I really be?’ Downturns do not mean we need to panic. Pay attention to the market while you remain prudent with your spending.
Jain advises founders not to panic:
In general, people should not really be panicking. In the same way, you know, I think when times are good, it’s not always a time to just open the floodgates and spend all your money. So, if you’ve been a prudent operator of your business, there really is no need to panic at all.
Aloor described the importance of telling a compelling story and connecting with investors, especially when money is tight. Aloor says storytelling has been and will continue to be at the heart of a successful start-up pitch:
Story matters, connecting with your investors matters. Trying to get them to understand what is it that made you the founder? What is it that prompted you to start this journey? Connecting with your funders is especially important here.
In addition, Aloor emphasizes how critical it is in choosing your funders to having a both a successful and enjoyable journey. Match yourself, your company, your product, your values, and your future with investors who will support and guide you will be a major factor in survival. Aloor advocates for female and racialized founders to focus on funds that primarily work with underrepresented groups:
Know whom you are pitching, know from whom you are going to ask for money. Getting to the right person, the right group of people can make that journey as a start-up founder so much easier for you than if you went to the wrong group of people.
During this downturn, become the company that’s fundable!
Will this downturn evolve into recession? And how long will this last? The responses among investors vary. “We cannot predict the future and we cannot predict the market.” This rude awakening may be merely a “contraction” in an otherwise normal market cycle. Most investors agree that companies living through this downturn “will find what a company needs to look like to be fundable is going to return to what is a more normal venture capital expectation.” In the meantime, this is a time for founders to regroup and re-evaluate the components of the business that will extend their runway and allow them to accelerate product development, while being conscious of expenses. This will be a true test of “creativity, true leadership, emotional intelligence,” and revealing how “nimble and resilient” a founder can be. Have the focus but be the “number one passionate person, that crazy person who wants to get this done.” Founders who balance this with “the burden, responsibility, and privilege” to lead their team through this crisis will be the “cream that rises to the top.”
This is an excerpt of the original article which appeared on Forbes and was written in collaboration with Taylor McAuliffe of Altitude Accelerelator.
