Well, it’s been a good run. For the last 13 years, startups have enjoyed a heck of a bull run, especially for tech companies. But as the saying goes, all good things must come to an end. And when it comes to investment experts in venture capital funding, nearly all are predicting a market teardown. Given rising inflation, geopolitical conflicts, and increasing interest rates, the writing seems to be on the wall. That means startups, particularly ones who will need capital infusions in the future, may need to rethink things. According to the expected changes in the VC landscape, a new startup strategy will need to be developed.
Fortunately, that doesn’t mean there’s nothing startups can do in planning for a rocky future. Indeed, access to venture capital funding will be notably less during a market teardown and readjustment. But there are a variety of things companies can do as part of their startup strategy. In many cases, companies have room for improvement and can tighten the ship to help weather the storm. Others may have unique opportunities that need to be exploited now rather than waiting months down the road. In any case, it’s important for startups to take a close look at their operations given the evolving economic climate today.
“We do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery like we saw at the outset of the pandemic…The era of being rewarded for hypergrowth at any costs is quickly coming to an end.” – Sequoia Capital
Different Pressures, Different Outcomes
When it comes to a market teardown, it’s easy to compare to recent events. Some may believe that any setback might mirror the recent Great Recession in 2008. The stock market suffered significant losses then, causing venture capital funding to fall for a time. But that was triggered by a housing bubble collapse, which no one expected currently. Instead, most expect home values to maintain their gains and continue to slowly increase over the next few years. Others liken current times to the challenges suffered during the early pandemic months. But many firms, including technologies, thrived during this time, generating tremendous capital supports. As a result, most companies had to readjust their startup strategy very little.
The economic pressures today are quite different, however. Inflation is rising and is expected to continue to do so over the course of the year. This has prompted the Fed to raise interest rates, which will further hinder consumer spending. Likewise, a post-pandemic adjustment by consumers is causing many pandemic business winners to suddenly experience setbacks. Netflix, Shopify, and Peloton are perfect examples of that. And of course, the volatile and unpredictable nature of the Russian-Ukrainian conflict further complicates matters. Because of these developments, the stock market is already showing signs of a bear market. And financial experts anticipate the worst is still yet to come.
“If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan.” – Y Combinator
What Startups Can Expect
Understanding the probable situation for the future, there are a few things companies can expect regarding venture capital funding. First and foremost, there won’t be as much of it to go around. According to some projections, global venture capital funding will decline by 19% quarter-to-quarter in the coming months. The market teardown will persuade VC firms to spend less and to be more critical of firms. As a result, the number of VC deals will decline, and the size of such deals will drop. It also means that other financing opportunities will evaporate for many companies in a pre-IPO phase. Given the limitations in accessing additional capital, it is highly recommended that companies adopt a new startup strategy to fit the times.
In addition to declining access to venture capital funding, startups can also expect lower valuations. With a market teardown, the potential value any company brings to the market will naturally be less. Therefore, companies should no longer expect past trends in valuation levels to continue. The erosion of a startup bubble will naturally further limit opportunities for financing and capital. Some startups will be affected more than others. These include international companies, those with heavy assets, and those in hard technologies. Low margin startups will also be more heavily scrutinized. All of these explains why a new startup strategy will be needed.
“Reevaluate your valuation, understand your burn multiples, and build scenario plans.” – Andreessen Horowitz
New Startup Strategy Considerations
A market teardown doesn’t mean all hope is lost, but it does mean a shift in startup strategy is necessary. During preceding years, venture capital funding has been abundant. High yields in some sectors along with competition among VC firms helped this situation. But now that the brakes are being applied, it will be important for companies to get lean and get mean. In other words, startups will need to do more with less while preserving the capital they have. Cutting costs and streamlining operations will be essential for survival. And most experts are encouraging startups to secure a 24-month cash runway based on expected market conditions. Many companies have already begun laying off staff as part of such a strategy.
Of course, not all companies will be in a position to extend their cash runway this long with additional funds. For these startups, securing venture capital funding sooner rather than later is essential. The longer such companies wait, the more difficult and more costly the access to capital will be. At the same time, all companies should develop multiple scenario plans as part of a startup strategy. Plan for the worst as well as the best and determine ways that best position the company for success. There’s little doubt many startups won’t survive the market teardown that’s anticipated. But among those that do, they’ll be stronger and more adept as a result.