How venture capitalists are advising startups on navigating the downturn

After over a decade of exuberance in the stock market, not mention last year’s record-setting pre-IPO valuations and fundraising, 2022’s reversal has startup investors warning of a prolonged slump.

As evidence, they point to grim news such as the cratering of tech stocks in the year’s first five months, coupled with the Nasdaq’s precipitous drop — putting it on pace for its second-worst quarter since the financial crisis of 2008

Meanwhile, inflation reached a 40-year high in May, the Consumer Price Index had reached a staggering 8.6% at the time of publication, and the Federal Reserve raised its benchmark interest rate by 0.75% in June, the sharpest hike since 1994.

All this has left venture capitalists, like the rest of us, skittish about the state of the economy. So how are VCs advising startup founders to prepare for this downbeat climate? Below we delve into their observations and admonitions.

It’s no longer business as usual

Economic headwinds are affecting businesses across industries, VCs warn. For example:

Investors aren’t plowing capital into startups like 2021: Global venture funding in the second quarter of 2022 is expected to decrease 19% quarter-over-quarter, according to CBInsights’ State of Venture report. U.S. venture funding is on track for a 13% drop in the second quarter, and deal activity is expected to dip by 22%.

Startup valuations will be hit: As inflation swirls, startup valuations are apt to drop and in turn beget “down rounds,” in which companies land new funding rounds at a much lower valuation versus their last post-money valuation.

Major public firms are announcing layoffs, hiring freezes: Snap, Meta, Salesforce, Uber and Lyft have either initiated hiring freezes or are expected to slow hiring. Robinhood and Peloton recently announced job cuts, while Netflix pink-slipped 150 employees in May and another 300 in June.

Private companies are thinning their ranks: Cloud software vendor Lacework recently laid off 20% of its employees, and as of July 6, some 315 private tech startups have dismissed employees since the start of 2022, per Layoffs.fyi. Buy now, pay later firm Klarna and celebrity video greetings startup Cameo have also initiated staff cuts, while Instacart plans to slow hiring.

VCs’ missives

Here is a sampling of how veteran VCs are advising founders in response to a market characterized by smaller funding rounds, diminished valuations and fewer completed deals:

Sequoia Capital – Regarded as one of Silicon Valley’s most successful VC firms, Sequoia is warning founders of a “crucible moment” and that it anticipates a long recovery.

The firm exhorts founders to spend less and to be frugal in its 52-page “Adapting to Endure” presentation, as reported by The Information.

“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 firm wrote. “The era of being rewarded for hypergrowth at any costs is quickly coming to an end.”

Y Combinator – The startup incubator, one of the world’s largest, suggests that founders revisit funding expectations as the boom period ebbs.

“If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn,” Y Combinator wrote in a May letter to its portfolio founders, as reported by TechCrunch. “Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan.”

Lightspeed Venture Partners – “The boom times of the last decade are unambiguously over,” Lightspeed wrote in a May blog post, adding that many CEOs will be forced to make tough decisions in order for their businesses to remain viable.

“Some will face tradeoffs that only a few months ago would have seemed outlandish or unnecessary,” the post read. “We see a silver lining, however, when hard decisions present themselves.”

A comprehensive look at VCs’ downturn strategies for startups

Boost efficiency. Instead of rapid growth, profitability and efficiency are the new watchwords for startups. Founders should expect more questions from investors about whether their product is a fit and whether the firm is capital efficient, or whether sustainable revenue could be achieved faster with a lower cash burn rate.

Investment will be prioritized for companies making a conscious effort to drive efficiency. In short, founders should utilize the time at hand to sharpen their business model to maximize efficiency.

Slow hiring. To improve the bottom line, consider devoting your best efforts to retaining your top talent instead of hiring new employees. Down periods are when you most need your high performers to come up with innovative solutions and motivate fellow team members.

Pare nonessentials. A downturn requires founders to reflect on their core business activities before making any investment decisions. Better said, startups should cut costs, eliminate nonessential activities and proactively look for ways to cushion their cash position to ensure survival.

Extend your cash runway. Startups should focus on extending their runways within the next 30 days. Those who don’t have the runway to make it to the default alive or have longer runways (12 to 24 months) should consider raising money now.

Be agile. As illustrated by the COVID-19 pandemic, agility is key to business survival in turbulent times. Work on building long-term operational resilience to withstand the downturn and beyond.

Brace for knock-on effects. An economic slowdown will bring its own ripple effects over time. Recognize the changing environment, and adjust your approach to market changes or shifts in consumer mindset.

Observe competitors. Don’t allow uncertainty to let you slide into thinking your startup exists in a vacuum. Be mindful of how competitors are managing their challenges to inform your own business decisions.

While these recommendations may have been deemed unnecessary or even unpalatable in the last decade, companies that employ these tactics and make critical changes now will be building a foundation for long-term success. Besides, they’ll be the ones to emerge stronger when the market normalizes.

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