“When”, Not “If” — Why Every Startup Should Be Planning for a Downturn

There’s been a lot of talk lately about the long-running bull market, an impending recession, and the implications for investors and consumers. But what does this mean for startups?

If you’ve been reading the headlines, these facts probably sound familiar: the global economy is experiencing one of its longest super-cycles in the last 100 years. We’ve seen global economic growth for more than 113 months — a record since the 1930s, and longer than the 1990–2000 super-cycle. Meanwhile, interest rates have been historically low, causing investors to seek higher risk opportunities in order to deliver decent returns. This has also created a massive inflow to alternative assets, including private equity and venture capital.

And the punchline that nobody wants to hear is this: winter is coming.

Source: Financial Times

At Sunstone, we’ve lived through enough economic boom & bust cycles to know that most good things do come to an end — or at least, a correction. In recent months we’ve seen more volatility in the stock markets, a significant slow-down in IPOs, and quantitative easing, along with trade war tensions between the U.S. and China.

The warning signs are there, and investors are starting to take heed. But what does this mean for startups? Is the macro-economic cycle really something that founders should spend their energy worrying about?

Worry? No. But, anticipate? Yes.

While I can’t predict the future better than anyone else, I do believe that macro-economic shifts pose an existential concern for startups. And here’s why: The average startup, across stages, is typically funded for 12–18 months, meaning they rely on a well-functioning financing and venture capital environment to raise future funds and sustain growth.

So when that ideal economic environment is interrupted (due to a correction or recession), investor money temporarily dries up, consumer spending slows down, and startups are left to wait it out. Although often — if they’ve only planned ahead for 12–18 months of runway — they don’t have the luxury of time.

As a venture capital investor and former asset manager I’ve seen this phenomenon twice before: during the dot-com crash and the financial crisis in 2008. The first wiped out an entire generation of internet startups (Amazon is a rare exception) and the second bankrupted thousands of startups, destroying perceived winners and creating new ones. Now, that all may sound very doom & gloom, but the important piece is what we learned from those crises, and how to better prepare for the next one.

While worrying won’t help much, some prudent planning and cash discipline will. Here’s a few recommendations that I think will prepare your startup for a potential downturn, and ensure your company can ride the macro-economic wave.

• Raise now rather than waiting for points of validation.
• Sell 10% of your shares in a secondary transaction in connection with your series B or later funding round. Take money off the table and secure yourself and your family. This allows you to take a long-term view and focus on your business without worrying about your private economy.
• Do not be overly tactical with respect to valuation / dilution — raise what you can. Accept 5% more dilution rather than optimizing a few percentage points.
• Don’t optimize for unicorn status (or any other valuation status). Be careful with aggressive liquidation preferences and anti-dilution clauses.
• Raise for at least 24 months of runway (and more if you can).
• Raise from a syndicate of investors. Some of your investors may not be around when further funding is required.
• Be prudent with your burn-rate and be careful about ‘buying’ market share with your investor’s money. Do like GE did in the old days; reduce your headcount with 10% starting from the bottom performers.
• Focus your business on profitable unit economics. This allows you to turn down your sales and marketing and reduce your cash consumption if needed.
• And as always with startups — cash is king.

I’ll summarize with a quote from Danish writer and cartoonist Storm P: “It’s difficult to make predictions, especially about the future” But, we’re gambling either way. All startups will be affected by a potential downturn (whether that’s “if” or “when”), so planning further ahead than the next 12–18 months could mean the difference between startup survival, or… the alternative.

Please share your thoughts in the comments below.

Jimmy Fussing Nielsen is a venture capitalist, a former asset manager and co-founder of Sunstone Capital. He is responsible for Sunstone’s investments in Boozt, Peakon, Seriously, Futureplay, Sourced, Exporo, Zolar, Orbex, Grandhood, RFRSH and others.