Thoughts on the Y Combinator email that’s floating around
The greater business outlook has been pessimistic, recently. There’s been tech layoffs, liberal Warren Buffett quoting (you know the one, “Only when the tide goes out do you discover who’s been swimming naked”), and a general fear for what’s next. There’s a feeling that the other shoe is about to drop. And, it’s only a matter of time until people start quoting Ben Horowitz’s ‘Peacetime CEO/Wartime CEO’ on LinkedIn.
A few days ago, Y Combinator (the famous startup accelerator) emailed all its startup founders with general advice for a potential downturn. And, that email has been making the rounds. But, like all other startup advice, you can’t just copy and paste it right into your small business. But, they make some good points and there’s plenty to learn from it.
(the 🤓 emoji indicates my thoughts, notes, and small business interpretation)
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:
- No one can predict how bad the economy will get, but things don’t look good.
🤓 Agreed, no one can predict how bad (or good) the economy will be. We can’t even predict if we’ll go into a full-scale downturn. And, while the issues worrying Y Combinator may not directly impact your business, they may be issues for your clients and your clients’ clients which could become a problem for you.
- 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*. [🤓 note: ‘default alive’ is a startup KPI summarizing runway, revenue growth, and profitability. Simply put, if expenses remained constant and revenue kept growing at the same rate, ‘default alive’ means you’d remain profitable and in business. All small business should already be aiming for default alive.]
🤓 In small business terms, this means cutting expenses, building your emergency fund (for both your business and your personal expenses), and if you’re really worried, applying for a credit line. Don’t count on another wave of EIDL/PPP/government grants, as sources of emergency funding.
- 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.
🤓 You probably don’t have investors and, if you do, they’re most likely friends and family that won’t invest during high inflation with a sinking stock market (unless they reallyyy believe in you and are looking for alternative investments). The small business equivalent would be applying for a credit line or term loan. If you’re going to need a loan, start collecting the supporting documents now.
- 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.
🤓 You may not have investors to make rich, but it’s still your responsibility to survive. You, your employees, and all your families are counting on those paychecks.
- 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. [🤓 note: VC = venture capital. LP = limited partner (of the VC firm)]
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.
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.
🤓 You obviously don’t need to worry about VCs or future funding rounds. But, expect to see a decrease in traditional capital and loans, as everyone battens down the hatches. Banks and other lenders will also be more disciplined.
- 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.
🤓 If you’ve recently started your business, think about your target audience, ideal clients, and how a downturn may impact them and their ability to pay you. Get ahead of their potential cost-cutting measures by better demonstrating your value (and staying on top of your outstanding invoices, just in case their cost-cutting measure is “don’t pay our vendors”). Show how your services impact their bottom line and make firing you a difficult decision.
- 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.
🤓 Don’t expect to hit your next growth stage on sheer optimism and strong forecasts. Growth stages like hiring employees, hiring middle managers, acquiring competitors, or selling your business will be harder to reach.
- 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.
🤓 If your current plan needs an optimistic business environment, rethink it. For example, if you need capital to survive, consider changing your plans.
- 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.
🤓 This is equally true for small businesses. The vast majority of your colleagues and competitors don’t have financial strategies, haven’t implemented financial best practices, and aren’t actively working on their finances (as opposed to you, who at least cares enough to read these emails every now and then). If there is a significant downturn, expect competitors to close up shop. Although, if that happens, your goal isn’t necessarily absorbing their market share (unless, you’re actively trying to scale). But, it’s an opportunity to pick up new ideal-fit clients, hire great talent, and come out of the downturn stronger than before.
- For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn
🤓 Honestly, this is a 35-minute video and I haven’t watched it yet. There may be some good advice in there, but remember, you run a small business and can’t copy/paste startup advice into it, so take it with a grain of salt. And, let me know if you’d like my thoughts on it (or, really, any other business advice ‘Michael Eckstein reacts to business advice’ would be a fun series).
All this being said, don’t panic.
Inflation, a bear market, and some Y Combinator email aren’t the end of the world or a sign of the apocalypse. Don’t go into crisis cost-cutting mode just yet. Be smart, be strategic, and plan for the worst but hope for the best. (And, don’t liquidate your stock portfolio without speaking to a financial advisor first.)
- Prune your expenses (eg, don’t slash, burn, and lay off employees)
- If you don’t already have one, build that emergency fund
- Think about how a downturn might impact your clients and revenue
🚀 Strategic Accounting 🚀 - In-the-trenches strategic and financial business advice and serious, candid conversations for small digital agencies (incl freelancers) for when you have the client work under control but need help with the business glue that holds it all together.
🏛️ Tax Compliance 🏛️ - Taxes, accounting, and payroll to keep your business on the IRS's good side