FOMO to JOMO: How to Survive a Downturn Economy

The days of the 100X ARR multiple are over. This past week, a16z published the “Navigating Down Markets” framework and wrote in jest:

Continuing our example, a $20M ARR business which last raised at $2B might observe the leading public companies in its space trading at 10x revenue, rather than 100x. Adjusting for the startup’s faster pace of growth, relative to public comps, let’s say that 15x ARR is a reasonable valuation for its next round of funding. This means their goal should be to reach $133M of ARR, or $2 billion divided by 15x, with 12 months of runway.

While there is still uncertainty and denial about the 2022 economic downswing, a clear operating playbook is already emerging from the fire. On Friday, David Sacks (of PayPal & Yammer fame) shared “Operating During a Downturn”, a recording of an internal presentation to his portfolio companies.

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Then kicking off this week, Marc Andreesen and his a16z gang livestreamed a late-night Sunday Q&A on how founders should make sense of the market.

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As founders face decision paralysis when the market environment flips on them, both of these videos share clear-headed advice on how to hard-shift goals from aggressively raising capital to adjusting the burn multiple. Depending on the revenue maturity of the company, the burn rate must quickly change to 1 or even 0.

What is a burn multiple? David Sacks wrote a deep-dive blog post on the topic. In short, burn multiple is the cash burned divided by net ARR added, i.e. how much do you have to burn to add ARR?

The priority for a company becomes staying alive. In this case, survival also serves a path to winning, since the competition that refuses—or is unable—to adapt will bleed out on their own.

The key points from these videos:

• The downturn will last for at least another 12 months, so make sure your runway can support surviving in an adverse environment.
• Rather than trying to predict what’s going to happen, contingency plan around base case, best case, and worst case scenarios.
• Best case: The company is able avoid raising capital for 24+ months. The burn multiple improves despite growing opex and customer acquisition costs.
• Worst case: High growth on less than 12 months of runaway. The company will need to pump the brakes on expenses through layoffs and slashed marketing budgets, while at the same time exponentially growing ARR.
• Quickly realize if you’re trying to force something the market doesn’t want. Don’t let customer acquisition costs kill you. Cut any sales and marketing spend that does not have immediate payoff within the next quarter. For early seed-stage companies, focus all activities on finding product-market fit. For later-stage companies, cut your losses early if a new product launch is floundering.
• This is the toughest topic, but layoffs can be minimized if they happen sooner, before the damage creeps into a larger demographic. Don’t delay if layoffs are expected and inevitable.
• F*ck massages, as Tony Fadell mentions in his new book. A downturn is an opportunity to rally the organization around the mission and re-focus on what really matters. This is a reality check to redirect employees’ attention from e.g. bickering about which flavors of kombucha to stock in the fridge.
• On the upside, expect hiring talent to become easier, salaries to normalize, advertising to become cheaper, and overall unit economics to improve.

Also related, check out Sequoia’s infamous “RIP Good Times” presentation from 2008. Same stuff, different day.

The Fragile Interconnectedness of Tech

How many profitable companies are making profits due to loss making customers?

Unprofitable customers is a nice to have, but never depend on them. Plan for demand reduction or even insolvency from this customer segment.

Whether intentional or not, there is an incestuous movement of money around VC portfolio companies. Throwing around the glut of VC money, these startups pay for the services of other VC-backed startups. This phenomenon in the ecosystem artificially inflates demand and pumps higher revenue numbers up the food chain.

On the flip side, the correction becomes self-perpetuating, as the ARR meltdown and layoffs have a rippling effect on all the others feeding from the same pond.

YCombinator’s Message to Founders

An internal email circulating publicly on May 19th:

Greetings YC Founders,

During this week we’ve done office hours with a large number of YC companies. They reached out to ask whether they should change their plans around spending, runway, hiring, and funding rounds based on the current state of public markets. What we’ve told them is that economic downturns often become huge opportunities for the founders who quickly change their mindset, plan ahead, and make sure their company survives.

Here are some thoughts to consider when making your plans:

1. No one can predict how bad the economy will get, but things don’t look good.
2. The safe move is to plan for the worst. If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days. Your goal should be to get to Default Alive.
3. If you don’t have the runway to reach default alive and your existing investors or new investors are willing to give you more money right now (even on the same terms as your last round) you should strongly consider taking it.
4. Regardless of your ability to fundraise, it’s your responsibility to ensure your company will survive if you cannot raise money for the next 24 months.
5. Understand that the poor public market performance of tech companies significantly impacts VC investing. VCs will have a much harder time raising money and their LPs will expect more investment discipline.
6. As a result, during economic downturns even the top tier VC funds with a lot of money slow down their deployment of capital (lesser funds often stop investing or die). This causes less competition between funds for deals which results in lower valuations, lower round sizes, and many fewer deals completed. In these situations, investors also reserve more capital to backstop their best performing companies, which further reduces the number of new financings. This slow down will have a disproportionate impact on international companies, asset heavy companies, low margin companies, hardtech, and other companies with high burn and long time to revenue.
7. Note that the numbers of meetings investors take don’t decrease in proportion to the reduction in total investment. It’s easy to be fooled into thinking a fund is actively investing when it is not.
8. For those of you who have started your company within the last 5 years, question what you believe to be the normal fundraising environment. Your fundraising experience was most likely not normal and future fundraises will be much more difficult.
9. If you are post Series A and pre-product market fit, don’t expect another round to happen at all until you have obviously hit product market fit. If you are pre-series A, the Series A Milestones we publish here might even turn out to be a bit too low.
10. 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.
11. Remember that many of your competitors will not plan well, maintain high burn, and only figure out they are screwed when they try to raise their next round. You can often pick up significant market share in an economic downturn by just staying alive.
12. For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn

Best,

YC

PS: If for whatever reason you don’t think this message applies to your company or you are going to need someone to tell you this in person to believe it… please reassess your beliefs on a monthly basis to make sure you don’t drive your company off a cliff. Also, remember you can always reach out to your group partners.

How This Ends

Fred Wilson (Union Square Ventures) published a blog post on May 22, comparing this recession to the early 80s, where the Fed dramatically raised interest rates (into the high teens) to control inflation brought about by spiking oil prices and stagflation.

Fred thinks we are still in the phase of barely entering the correction. Like a train wreck in slow motion, the economy has barely blinked at what’s happening, and stocks have yet to fully bottom out. Fred is more conservative than Andreessen’s sound bite above, and recommends preparing to ride out a recession for at least 18 months.

The Changing Tech Environment

On June 2, David Sacks joined Elad Gil in a fireside chat at SPC-SF. David elaborates on what’s happening in the startup fundraising market and how founders should respond.

• How have the markets shifted?
• What should your company do about it?
• Playing offense and defense in rough waters

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