A few months ago, I was asked by a very thoughtful B2B founder in our portfolio if he should be spending time building a downturn plan. It’s a great question, and one not to be taken lightly. At the time, things in the venture world were – and for the most part still are – going along swimmingly. As we reported in last quarter’s NYC Seed Deal Report, 2018 is on pace to see the most venture dollars ever invested in private companies across the country. New York has followed suit, with a sharp increase in Q3 deals and dollars from Q2, and a continuing trend of growing deal size. Even more significantly, total funding for Q3 hit $87.6 million in NYC – a figure we haven’t seen since Q1 2016. In short, things have been very, very good.
So is it really time to start planning for a downturn? When I had this conversation three months ago, my response to this founder was along the lines of, “Hope for the best, prepare for the worst.” As someone who vividly remembers Fall 2008 (and Spring 2000, for that matter), I’m always keenly aware that no matter how good things may seem, they can change quickly. When (not if) the next downturn happens, it will be messy, and building a startup off your heels is almost never a winning strategy. But I’m also a realist, and startup founders have a million things on their plate. When things in the market are good, it just doesn’t make sense to spend the time and resources drawing up a full-blown downturn plan. That said, it’s always valuable to have thought through some high-level questions that will help steer a company in the right direction once a downturn does become imminent.
I advised this founder to spend time focused on ensuring that his product was safely in the “need to have” vs. “nice to have” camp, and therefore would be less likely to fall victim to shrinking corporate budgets. I asked him to think, at least directionally, about where he could streamline his operations if the need arose. And I suggested that he make absolutely sure that he had a clear and detailed understanding of his cash forecast over the next 18 months.
I’ve been thinking back to this conversation as I’ve watched some significant cracks begin to appear in our ecosystem over the last couple of months. Later-stage firms are definitely becoming increasingly selective. We’re seeing the best companies pull down impressive rounds, while solid, but not spectacular, companies are having difficulty raising capital. The bar has been raised.
But more pressingly – and these are the real canaries in the coal mine – are the macroeconomic factors. Tech stocks are getting hammered, as we’ve all seen, with NASDAQ down over 12% over the last three months, and the FAANGS having seen over $1 trillion in market value wiped out from their 52-week highs. Then, of course, we have our volatile and wildly unpredictable administration that continues to escalate trade tensions and general geopolitical instability. Venture investing doesn’t exist in a vacuum, and just because VCs have historically large amounts of cash on hand, broader economic factors are always top of mind.
I’m not a naysayer, I’m an experienced realist. Though investment numbers have continued to go up (for now), especially in our fair city, it shouldn’t be a surprise to anyone in a few quarters if we find ourselves in a completely different place. So, as companies work actively through their 2019 planning, I’m revising my original advice to this founder, and urging all founders to look at the next 12 months at least partly through a more conservative and cautionary lens. Now is certainly the time to be not just thinking about a downturn, but putting pen to paper and drawing up a game plan that will help you brace for impact and weather the storm. Below are some critical questions for consideration that will help you get started:
- Are you necessary? This is a question that should always be top of mind for founders, but it’s exponentially more important in a downturn when customers cut back on unnecessary items. Are you doing enough from a product and customer success standpoint to be in the “need to have” bucket? What can you do to get yourself more deeply embedded into your customers? Are you making the personal connections with your customers that might help them feel more compelled to stick with you?
- Could trim your own “nice to haves”? Create a rough framework for how you’d react in the event of a downturn. Be extra careful of ramping up burn in 2019, and highlight the parts of your operations that might be considered non-essential. Be prepared to pull those back if need be. That’s a healthy discipline in any sort of market, but it becomes even more critical in a down market when all of your focus should be on revenue-producing activities. And don’t be afraid to do some proactive trimming now if you discover things that just aren’t needed.
- Is your customer base diversified? Consider your end user. If you have a lot of venture-backed customers, work like hell to offset them with as many “real economy” customers as possible. Startups selling to startups are the first to die when things get nasty.
- Do you have runway? My rule right now on this is simple: If you don’t have a year of cash on hand, and you’ve made good progress since your last financing, get the hell out the door in January and raise some money! Prices and multiples will certainly begin to moderate over the coming quarters, so time is of the essence here. While you may feel like you’d prefer to wait 4-8 months for a time when you may be more valuable, I’m advising most companies that the capital markets risk associated with that delay just isn’t worth it.
This may all sound doomsday-ish, but it’s not. I don’t know when things are going to turn or how bad it’s going to be when it does. What I want is for companies to be realistic and prepared when things do turn. Do a bit of work to get your organization’s head in the right place. And then, in this holiday season, let’s give thanks for the great run we’ve had, for the progress we’ve made, and for the wisdom of hindsight that will enable us to plan thoughtfully and expediently for whatever comes our way next.