Building Startups in a Bear Market đ»
Some of the founders and early startup employees among you might be thinking, âWhat do bears have to do with growing revenue and hiring?â While Iâm not sure whether to respect your commitment to heads down building or to be appalled by your ignorance towards all non-startup related things, Iâll try my best to elaborate.
Many, like myself, who entered the workforce within the last 10 years, have been privileged enough to experience a predominantly bull market. Sure weâve had our fair share of short-term selloffs, but nothing has felt quite as uncertain and potentially bearish as the state of the market now. The macro environment is heavily impacted by geopolitical uncertainty, from impending rate hikes to foreign conflicts, and the stock market is beginning to bleed in response.
A downturnâs effect on the startup ecosystem is two-fold:
- Extreme movements in the public market will trickle down into the private markets. Growth stage startups are already seeing the impact on their valuation multiples, as larger firms begin to slash valuations. While this is unlikely to affect the early stages as much (Pre-seed, Seed, even Series A), everything beyond that should begin to feel movement. The days of the common 100â200x multiples will soon be behind us. When we consider that public listings accounted for a majority of startup exit value in 2021, we realize that the incumbents that represent the comparative TAM for many of these startups have been significantly impacted.
- The rate of new venture funds will slow. The logic behind this is fairly intuitive. LPs in venture funds have diversified their capital among a number of different assets. As their public market portfolios shrink, the weighting of the venture funds in their portfolios grows heavier, and theyâll want to rebalance in response. While the many, many funds that have been raised in the past year will still deploy their capital, we can expect fewer funds to emerge in a bear market.
Letâs not hit the panic button yet. Thereâs an argument to be made that itâs too early to call it a bear market, but I like to be at least a little prepared. Candidly itâs also fun to imagine all the startups that will die if we enter a recession. For those startups that want to be prepared for the onslaught of the bears, here are some things to keep in mind.
Become Default Alive đ§
In his seminal essay, âDefault Alive or Default Dead?â, Paul Graham describes the ideal state of a company as being default alive. A default alive startup should be able to continue indefinitely if it receives no more funding, assuming expenses remain constant and revenue growth is what it has been over the last several months. In recent years, weâve seen an incredible emphasis on growth at all costs. As a result, companies have trended towards more aggressive fundraising cycles, often planning for only 1â2 years of runway. In a bear market the availability of fundraising capital will diminish over time, so it becomes crucial that a company is able to sustain itself without a new influx of venture cash.
As Paul prudently points out, VCs will often encourage you to err on the side of over-hiring. When things are going well, this seems on the surface to be a reasonable strategy â there are so many things to work on and you donât have nearly enough hands. However, this will only work if you have sufficient product-market fit. Without a strong enough market pull, companies often fail to meet their growth expectations regardless of how much they have hired. Instead, they suddenly have much higher expenses and not enough revenue growth to match.
It would be unreasonable to expect a super early stage company to be default alive, but as your organization matures you should expect to move quickly away from default dead. In a bull market, daddy venture capital will come feed you, but in a bear market, you starve because he left for a hotter startup.
Lower that Burn Multiple đ„
One major KPI youâre going to want to track in a bear market is your burn multiple. Coined by investor & entrepreneur David Sacks, a companyâs burn multiple is simply a representation of its burn relative to its revenue growth. The lower your burn multiple, the stronger your product-market fit.
In a similar fashion to a companyâs default alive status, it would be unreasonable to expect this multiple to be low early on. However, your companyâs capital efficiency should increase as the company develops. If you find that your burn multiple is not decreasing over time, youâll want to entertain the notion that you donât have as much product-market fit as you might think. Take another look at your KPIs to determine your areas of weakness; if they all look strong, you probably have the wrong KPIs⊠because if you have to spend a lot of money to move your revenue needle a little, you have a bad business. This is true in general, but it becomes especially apparent in a bear market.
Donât overpromise đ€Ą
I know some of you might find this suggestion egregious. Youâll find it difficult to not promise candidates the world, to not tell them that youâre looking to build an enduring company thatâs once in a generation, one that will rocket to the moon, make them rich beyond their wildest dreams, and endure beyond your and their lifetimes. But building a startup is already hard, and itâs even harder when the economy is tanking. If youâre not candid about the success rate and the difficulties ahead, you likely wonât hire people who will stick through the tough times.
As Ben Silbermann, Co-founder of Pinterest, put it in Bessemerâs âBuilding a startup during a downturn,â
I would embrace the hard things as a screening mechanism for whoâs in this thing for the right reasons.
Early-stage startups in particular are rife with feeble attempts at a reality distortion field. The number of Seed and Series A stage companies that tell me they have product-market fit is actually unreal. They use LOIs as indicators of market pull, they talk about how many firms are already interested in their next fundraise, and, my personal favorite, they quote ARR numbers that are extrapolated from incredibly small sets of data. These persuasion tactics might work on the less cynical, but in a bear market, companies will find that this will only increase their churn. In a downturn, employees will become disgruntled faster, and they will leave as they determine the reality of their situation.
Startup churn in a bear market will be higher than in a bull market, so youâll want to be more measured in your approach to both hiring and communication. If youâre real with your team, youâll find teammates that are there for reasons independent of the macro environment.
Beware the Burnout â ïž
Burnout is one of the largest and most underrated causes of startup death. A startupâs journey is always strenuous, and none are immune to the stress of the ups and downs a company will face in its lifecycle. When you factor in public awareness of the low startup success rate, it becomes easy to see why startup employees can get easily disillusioned or depressed. In a bear market employee financials will take a beating outside of the startup as well, so those negative emotions will be amplified.
Thereâs no catch-all solution when it comes to mental health, but it is important to keep a pulse on your teamâs well-being throughout the arduous building process. Team off-sites are a helpful way to alleviate stress and build camaraderie, and some time in 1:1âs can be utilized to communicate early and often about team sentiment.
Seize the Opportunity đ
Luckily itâs not all dead startups and depressed founders in the land of the bears. Thereâs a pretty strong argument to be made that down markets are the perfect time for next-generation companies to be built. A byproduct of the increased churn is more people looking to switch jobs, particularly with in-demand roles such as engineers or designers. This means there will be more candidates to choose from, and the truly skilled operators will gather at the most compelling companies.
A startup culling would separate the wheat from the chaff, leaving only the nimble, resilient startups in its wake. If youâre able to emerge from the smoldering ashes of the bear market victorious, then youâll find that youâve built a quality, antifragile business. Companies that defined the last decade, such as Airbnb and Uber, were built during economic downturns, and yours might very well be the next standout company.
Some other things Iâve written:
- If youâre thinking of investing in startups but youâre not rich.
- If youâre thinking of starting a company now or in the future.
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