'Avoid the Death Spiral': Multiple VCs have blasted out warnings to founders on economic doom. Here's what they are advising.
- VCs are writing to their portfolio companies to warn them of the turbulent times ahead.
- Investors are advising startups to cut costs and conserve their cash.
- Some VCs say this is the best time to start a company and emerge stronger for the long-run.
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The moment of reckoning VCs have been dreading might finally be here.
After investors poured record-breaking amounts of venture money into startups this past year, a spate of disappointing performances from tech companies has investors anticipating a slump, with startup valuations beginning to drop.
Data from CB Insights pointed to an expected 19% decline in global-venture funding for the second quarter. Sectors that typically excite VCs could also see less funding. CB Insights said fintech funding would see a 28% drop, digital health would see a 25% drop, and retail tech would see a whopping 50% drop.
Startups like Thrasio, Cameo, Noom, and MainStreet are turning to cost-cutting, layoffs, and even looking for buyers.
Like other downturns, including the one at the beginning of the pandemic, investors sought to assure their portfolio companies that things would work out while warning them to brace for turbulent times. In the financial crisis of 2008, investment titan Sequoia Capital famously cautioned founders to cut costs, and "spend every dollar as if it was your last," in its "RIP Good Times" report to its portfolio. The firm delivered a similar message to startups as the dot.com bubble burst in 2000. Sequoia just issued their own warning to their portfolio about the recent downturn, cautioning founders of this "crucible moment," in which they need to cut costs and conserve cash.
Many VCs are drawing inspiration from Sequoia's infamous 2008 pitch deck, cautioning founders in internal and external memos to prepare themselves for the downturn.
Many of these warnings came in memos, but some VCs preferred to speak directly to founders.
For example, Ammar Amdani, the cofounder of Adapt VC, says he's been scheduling meetings with all his companies to address their financial needs in the months ahead. Carter Reum, founder of M13 Ventures, also says he's been communicating individually with each of his companies.
Here is a round-up of what some VCs have told portfolio companies about how they should prepare for a continued downturn.
Andreessen Horowitz outlines tangible steps to get back on track
Andreessen Horowitz is among the most well-known VC firms in the game and shared the advice they give to their own companies in a post on their editorial site, Future.
The firm provides startups with a framework for analyzing three important metrics in a downturn: re-evaluating valuations, understanding burn multiples, and building scenario plans.
Since public-company valuations tend to reflect downturns more quickly than private ones, the firm advised startups to pick a public company in a relevant sector and recalibrate their valuation based on how much the former has dropped.
Next, the firms says to focus on "burn multiples," which is defined as cash spent by a startup divided by the annual projected revenue.
"We like burn multiples more than other efficiency metrics for recalibrating when market conditions change because they are all-encompassing of your business activities," the firm said in the memo.
They also noted that scenario planning is important during macro events like inflation and supply-chain shocks. Companies should create plans for the base case, best case, and worst case scenarios so they can quickly adjust their spending to their performance.
"Some of the strongest businesses are forged in the toughest times, and often, those that survive when the market turns are rewarded with increased market share and leaner, more efficient operations," the memo concluded.
Here is the full note.
Bling Capital says rein in spending
Benjamin Ling, the founder of early-stage venture fund Bling Capital, believes that investor sentiment is the most negative it has been in over a decade. He's not sure whether the downturn will last a few months or a few years.
"Given the uncertainty in duration, startups would be wise to carefully evaluate and reign on their spending in a market where capital is very expensive," he said.
Brooklyn Bridge Ventures advises seed and pre-seed startups to act now
Fundraising may be more sluggish these days, but Charlie O'Donnell recommends forging ahead anyway — even if the environment is less than perfect.
"Ditch the need for a lead," he advised startups in his weekly newsletter focusing on the New York innovation community. "Sure, it's nice if you get one, but if you're raising a seed or pre-seed, just pick a reasonable number and a minimum close amount."
O'Donnell's firm, Brooklyn Bridge Ventures, focuses on seed and pre-seed startups and has made investments in credit-card fintech Petal; direct-to-consumer grocer Hungryroot; and paint startup Clare.
Ensuring you have enough cash to reach a milestone "everyone can get excited about" — whether it be product development, a launch, or making headway on revenue — can get investors excited in the future.
"Just get the ball moving," he said. "Are you in or are you out at X price, if we get Y amount of money in? Doesn't need to be more complicated than that."
Cantos Ventures takes a different approach
Ian Rountree, a managing partner at Cantos Ventures, noticed his founders were already being flooded with cautionary blog posts and internal memos on how to prepare.
"They became repetitive and went from helpful to depressing," he said. He decided to take a different approach to addressing his portfolio companies. "I've more or less flipped and am cheering them on!"
In a tweet from May 17, he shared that Cantos was continuing investments despite the downturn. He told strong teams to "stay calm and build on."
<blockquote class="twitter-tweet"><p lang="en" dir="ltr">Two more deep tech Series B term sheets in the <a href="https://twitter.com/cantos?ref_src=twsrc%5Etfw">@cantos</a> portfolio this week, both decent up-rounds<br><br>Consider cash burn carefully but if you're an awesome team with killer tech, a strong mission, and a massive margin opportunity then stay calm and build on🧑🏭👷🧑🔬</p>— ian 🔮🪤 (@IanRountree) <a href="https://twitter.com/IanRountree/status/1526680931880144897?ref_src=twsrc%5Etfw">May 17, 2022</a></blockquote> <script async src="https://platform.twitter.com/widgets.js" charset="utf-8"></script>
He also shared a piece of advice Sequoia relayed to one of his portfolio companies it also backs: "To raise extra cash if they can and focus more on near-term revenue."
Cowboy Ventures warns of a rocky two years
Early-stage investor Cowboy Ventures, a VC firm founded by Aileen Lee, said it told portfolio companies to expect a rocky two years of fundraising and to do scenario planning to be prepared "if things like churn are worse than expected."
In an email, Cowboy Ventures partner Amanda Robson said the company has asked founders to focus on efficiency metrics.
"We have the benefit of multiple Cowboy partners like Aileen [Lee] and Ted [Wong] having lived through few cycles," Robson said. "We have also been having one-on-one conversations within the portfolio-advising companies based on their specific markets, customer bases and sales and support motions on how to best plan for the next couple of years."
Craft Ventures recommends startups be open to accepting a lower valuation
Craft Ventures, an early-stage venture firm based in San Francisco, took an unconventional approach to communicate with founders.
Instead of a note, phone call, or one-to-one meeting, the firm uploaded a 55-minute video to its YouTube channel. In the video, co-founders David Sacks and Jeff Fluhr address four main points about the downturn: what's happening in public and venture markets, how the current moment is similar to downturns in the past, and they offer suggestions on what founders can do right now — including raising more capital and being open to lower valuations.
"This is one area where VCs are better positioned than founders to see what's happening because we are in the market for capital every day, " Sacks says. "Obviously it's your companies, you run them. We're giving you this information so you can adapt as quickly as possible and survive this downturn."
Financial Ventures Studio believes now is a good time to start a fintech
Fintech investor Financial Venture Studio warned portfolio companies that while "the extreme valuations of the past couple years have largely evaporated," there are still opportunities.
The fund's managing partner Tyler Griffin told Insider they have muted optimism.
"Nobody knows how long this will last, but the economy is not fundamentally broken, and innovation in financial services is needed now more than ever," Griffin said. "Now is a great time to start a fintech: early, seed-stage funding is still available. IPOs for a new company are years off; times like this raise the salience of fintech and increase the positive impact great companies can have on their customers."
Griffin added his fund believes differentiation "has never been easier" regulators will make banks rely on fee income and drive consumers to more digital, low-fee offerings.
Financial Venture Studio noted that firms could receive available funding and it is still looking for companies to work with, but warned that prices would not be as high. In addition, late-stage rounds will also take longer, so portfolio companies should expect more extended rounds.
Griffin had one final warning for startups.
"Crypto is not immune."
Initialized warns startups against rushing to raise a Series B right now
The market has shifted from its founder-friendly peak around a year ago, presenting challenges for startups that earned a high valuation then and are now considering another round of fundraising.
Proceed with caution, Alda Leu Dennis, an Initialized partner, said in a recent blog post.
"Given current market conditions, the baseline metrics required to raise a Series B have shifted," she wrote. "With talk of a potential recession and economic tightening policies underway, VC firms have begun to scrutinize new deals from a more defensive position."
Dennis said that while many founders have continued to seek capital, there are fewer successful rounds these days. She's advising startups to weigh their need for cash to grow — and potentially taking a hit to valuation during a funding round — against waiting until the markets normalize.
"Personally, I think that any rush to raise right now would be viewed as negative signaling for nervous VCs," she said. "Don't let a panic fundraise poison the waters — be thoughtful and take some time to pull the data together, craft your story, and practice your pitch before heading out there."
Lightspeed Venture Partners offers advice on staying optimistic and emerging stronger
Lightspeed Venture Partners, a global venture firm that focuses on multi-stage investments, posted a memo on Medium titled "The Upside of a Downturn" earlier this month.
The note offers advice on how struggling startups can make the most of the current situation and come out stronger.
It focuses on seven main points that included suggestions for morale like "stay optimistic" and "survive before you thrive." The firm reassures companies that since growth is slow at the moment, investors will not fault them for momentarily putting big ambitions on pause.
They also offer practical advice like "cut nonessential activities" and "revise assumptions based on talent." One of the silver linings of a downturn they say, is that companies can focus on recruiting talented people they didn't have access to before.
The firm reiterates that companies should strengthen their fundamental operations right now and keep in mind that the slowdown is temporary.
"Our hope is that your resolve remains strong in the coming year. We look forward to helping founders navigate the difficult choices ahead, and continue to build generational businesses," the firm writes.
Here is the full memo.
Mendoza Ventures: 'Don't look at social media'
Mendoza Ventures, a Boston-based fund investing in fintech, AI, and cybersecurity, made sure its founders steer clear of market noise.
"We tell them to turn off their computer for a minute, or at least social media, because the amount of noise in the space versus the change in money flows are not matching up yet," Senofer Mendoza, Mendoza Ventures founder and general partner, said.
Mendoza added that she's told portfolio companies to "focus on sailing your own boat and if something crashes next to you, don't worry about that, that's their boat."
Mendoza said one of the things her fund has impressed upon founders in the past few days is the importance of fintech in people's lives. She believes that if a company's products have the power to change people's financial lives, they will always be necessary, especially in a downturn.
Sequoia cautioned founders of a "crucible moment" and to avoid a "death spiral"
Sequoia Capital, which famously advised founders after the 2008 financial crisis and dot-com bubble to proceed with caution, just warned founders of a "crucible moment," according to a presentation to founders that was first published by The Information.
The VC firm said that founders shouldn't expect a quick economic recovery and that startups should extend their runway and quell excess costs.
"Don't view [cuts] as a negative, but as a way to conserve cash and run faster," the memo said.
Sequoia also warned about the potential for startups to "avoid the death spiral" in the current environment as monetary and fiscal policy tools that helped immediate pandemic recovery has been "exhausted."
Wing VC: 'Building an enduring company is a marathon'
Wing VC told their portfolio companies that even though the market seems to be moving slower, there is still capital available at a different level than what they're used to.
"It's a bit of a falling knife scenario where folks aren't sure where the bottom is and desire to find social proof with whatever the new market pricing is," said Jake Flomenberg, a Wing VC partner, in an email. "That pricing will take a bit longer to emerge in the early stages of the venture market so in the short term fewer deals are getting done. Medium-term, capital will be available, just in the new pricing regime."
Flomenberg said the advice he gave to founders is to not panic. He told portfolio companies fundraising will be harder so they would need to remember that "building an enduring company is a marathon and bumps are expected along the way."
Wing said companies should do more with less and "recalculate the cost/benefit of additional expenditures given the rising cost of capital."
The VC plans to work with its portfolio companies to review their operating plan in light of current market conditions.
Y Combinator warns startups to stay away from fundraising market
Y Combinator sent a message to founders through its internal-alumni platform, the incubator confirmed to Insider, as many of them worried about possibly changing plans to hire, spend or raise capital.
Y Combinator told founders that while no one can predict how the economy will behave, "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," the memo said. "If you don't have the runway to reach default alive and your 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."
They added that when public-tech companies perform poorly, VC investing is also impacted as funds cannot raise as much capital.
The incubator warned companies still looking for product-market fit shouldn't expect another round "to happen at all until you have obviously hit product-market fit." Startups looking to raise cash in the next six to 12 months should also rethink their plans.
But Y Combinator still maintains that companies "can often pick up significant market share in an economic downturn by just staying alive."
"If for whatever reason you don't think this message applies to your company or you are going to need someone to tell you this in person to believe it… please reassess your beliefs on a monthly basis to make sure you don't drive your company off a cliff," the memo said.