Founders: Here’s How You Can Ride the Current Market Downturn
You’ve probably heard the recent letter from YC. “Plan for the worst”, they’ve said to their portfolio founders. It certainly doesn’t paint a positive picture of the future for startups.
At eFounders, we like to be pragmatic about the current situation.
Here are 7 tips to consider to ride the current market downturn:
- Default alive, default investable: assess your cash needs to reach your next milestone
- Be prepared for a slowdown in ARR growth
- If you have good unit economics, raise non-dilutive financing to support your growth & innovation
- Increase communication with your teams
- Cherry-pick key talents as competition should cool down
- Make sure your ESOP strike is still relevant to offer upside your teams
- Be ready to see an acceleration of consolidation/M&A: weigh the opportunities vs risks and revisit the buy vs build dilemma
Let’s have a look at these in more detail.
Default alive, default investable: assess your cash needs to reach your next milestone
We’ve just been hit hard by a stock market crash and everyone is still waiting to see how it will play out. We believe the Tech and SaaS sector will bounce back in the long run despite the crash and rising inflation. Today, there is no industry with more potential for growth and inflation hedge than SaaS, Fintech, Blockchain etc.. This will fuel the appetite of founders, talents and investors in the long term.
There is still a lot of dry powder in the markets so we’re betting that funding rounds will recover — even though valuation, dilution, terms & conditions will be different. Be prepared to see a flight-to-quality and a strong focus placed on efficiency from investors.
There are a lot of great resources out there on how to manage cash. We strongly recommend a very insightful article from a16z on the topic (A Framework for Navigating Down Markets) that focuses on burn and growth scenarios in order to be in a good position for your next round. We like the fact that it provides a great framework to help you make decisions: a scheme that will need to be revised going forward based on your actual growth and market valuation multiples. In any case, go out and speak with your investors/Board as they might prove very helpful in lending you guidance.
When building your case, be prepared for a slowdown in ARR growth
One of the main challenges Founders face in the current market environment is understanding how their business will be impacted in the next 12–24 months: SaaS and Tech companies will not be affected on the same level and discrepancies are to be expected between sub-sectors (security, fintech, infra, etc) and target customers (enterprises, SMEs).
Startupland is a relatively closed ecosystem: your main clients are very often other startups that will aim to reduce their spending to protect their runway. You should automatically expect less growth in the short to medium term.
If you have good unit economics, raise non-dilutive financing to support your growth & innovation
Historically, startups have been financed with equity which better reflect their high-risk profile. Nonetheless, with the recent increase in the cost of equity, raising non-dilutive financings has become a more attractive option to extend runway and support additional investments in sales, marketing or R&D.
A lot of players have emerged providing different sources of debt: traditional debt, venture debt, revenue financing etc. We recommend opting for a funding strategy that aligns with your finance, sales & marketing objectives and assessing whether you want to leverage short-term maturity instruments such as Revenue Based Financing, versus long-term runway increases such as traditional or VC debt. We have recently seen a strong appetite from commercial lending banks to enter the startup environment by providing longer maturities — up to 5 years in some cases.
Debt providers do not tolerate risk as well as equity providers; the best time to raise debt is when perceived risk is at its lowest, i.e. directly following an equity round, or at least when you have at least 18 months of runway. This is important as depending on the nature of the debt providers (traditional lending bank vs venture debt fund for example), the process can take several weeks/months.
Increase communication with your teams
An important part of your job in the coming months will be to keep people motivated and dedicated to their work. Oftentimes, there is a strong disconnect between founders knowledge of the market outlook and that of their teams. Teams easily feel left in the dark with regard to their company’s health.
I can only encourage all Founders to communicate more during these times of uncertainty. It is great timing to reinforce and unite teams to face headwinds. You’ll collectively come out of it stronger.
Cherry-pick key talents as competition cools down
We can expect competition for hiring to cool down a bit: your competitors might be more cautious about spending on recruitment. If you have the cash, now can be a good time to take advantage of the market and cherry-pick key Talents.
Make sure your ESOP plan is still relevant to offer benefits to your teams
Bear in mind: as valuations decrease, employee stock option plans (ESOP) become less attractive. Be careful as ESOP can become completely nullified if the strike price from the last round is perceived as too high. In the US, many companies have started updating their 409A to lower their strike price. We can only encourage this trend.
Having an ESOP plan that is well in the money is a great way to attract and retain the best talent.
Be ready to see an acceleration of consolidation/M&A: weigh the opportunities vs risks and revisit the buy vs build dilemma
There will be some consolidation in the tech space that you want to take advantage of.
Downturns have always been a catalyst for merger & acquisitions (M&A) and acqui-hire. As a Founder, you should keep a close eye on trends: are there some larger and well-funded players that you could partner with? Have you identified a great team that has built a niche complementary product? Is there a risk of concentration among your competitors?
M&A are diverse but there are a few typical use cases: vertical M&A, where you strengthen your position on the value chain by acquiring a specific technology (for example a key supplier) or a large client. Horizontal M&A, when you target direct competitors in your home-market (that can have a different market positioning or product offering) or abroad to expand geographically.
If you believe in the long-term trends of your industry, downturns are the perfect opportunity to take advantage of lower valuations and grow quickly. From an efficiency perspective, it is also a way to benefit from economies of scale that are key in generating profits.
At eFounders our core business is building great companies. We are less impacted by public markets because the ventures we are building still have a very long road before going public or M&A. We are extremely confident that now is an amazing time to build.