October 2008, Sequoia Capital, issued a missive to its portfolio companies titled R.I.P. Good Times in the wake of the global financial crisis. Sequoia advised its companies to reduce costs and start generating profits as soon as possible. Mar 2020, Sequoia again published an open letter offering similar advice to its portfolio companies in response to another global crisis (Calling the coronavirus outbreak The Black Swan of 2020). The fund urged its portfolio companies to “question every assumption” about their business, and consider cutting jobs and spending.
Comparing two eras is difficult. One thing is clear – This is easily the worst crisis for startups, and for the broader economy as well, since the Great Recession. In every aspect of their business, from fundraising to customers to employees and suppliers, startups are struggling to cope with the impact of the virus. And the problem isn’t just about fund raising. It is going to quickly turn into a cash flow problem, specially for those that have until now given priority to customer acquisition instead of generating profits.
And the problem cuts across; Sector wise and as well as Stage wise. Startups that provide flight and hotel bookings have naturally been the worst-hit. The gig-economy firms including Ola, Uber and Airbnb, are seeing a drop in demand. Co-working spaces, world over, have taken a beating. All these sectors will suffer more in coming weeks with the travel sector likely to see a fall for many months to come.
In the FinTech space, Lending companies will have to deal with a paradox – more people will need loans even as an increasing number of existing customers may find it tough to make repayments…a classic Catch-22 situation! Wealth management startups are expected to see a drop in business as market volatility is at its peak in recent years. The impact on payment apps is not yet clear as the country’s financial system is already reeling under the burden of Yes Bank’s collapse. On the whole, caution and a wait-a-watch approach are clouding the mood within the world of startups.
A few sectors have gained as well. Gaming, streaming and online education content providers are all reporting a significant increase in users and time spent on their platforms. Food & grocery, medicine delivery should also find an uptick in their business.
Given the uncertainty, funding will be a challenge across the board, whether one is early or late stage company. In our last article, we talked about over-capitalization & if we are building the right kind of companies. There are a number of late-stage heavily funded companies that have never worried about Unit Economics or becoming profitable. Their only mandate has been customer acquisition, whatever may be the cost. They will now start to get lot of pressure from their investors to get the model corrected. These startups will need serious money to survive but good thing is that venture capitalists won’t let their existing bets die. Call it by any name, whether it is a Sunk-cost fallacy or inherent conviction in those startups, such companies can still look up to their existing investors to keep them alive.
Of course the losers in this would be those mid-segment startups which have been trying to raise new funds from such VCs. But they would find VC in no mood to make any new investment or take any new bets for now.
For early stage-startups, seed-funding has always been a challenge. They need to build partnerships with local networks, accelerators, HNI, Angel Investors and try to work closely with them to get some much needed fuel and more importantly stakeholders to support them. In a deteriorating market, the eventual price/terms will be less favourable than your price/terms. Don’t over-negotiate price (focus on the terms likely to impair future financing, but don’t haggle too much over those).
Being in the thick of action, what do we recommend?
One, whatever the stage may be, for startups, all actions now should lead to increased credibility and fundability in future. That should be the guiding principle to take any action.
For Angel Investors, while wary investors will steer clear of new ventures, there will be a select few hoping to swoop in to support promising, robust businesses. Look for good deals right now when you could work the numbers in your favour.
For ecosystem-building players like us, it is critical to keep working closely with startups. In a market where early-stage startups are already deemed risky, and are disproportionately underfunded as a result, the pipeline may be at risk of drying up. We need to ensure budding startups get all the support & guidance they require in these testing times.
So what happens next?It is early days yet, and we don’t yet know how bad this economic downturn is going to be. It will certainly be a while before we know for sure what the impact on the startup sector will be. Everyone is acting in a knowledge vacuum. But overall it may not be all gloom and doom. It’s a market, and valuations will ultimately adjust downwards to the point where investors perceive they’re getting a higher return for their higher perceived risk.
By the way it is very interesting to see what Sequoia did after the “RIP Good Times” message. Rather than following-on their own advice & slowing down, Sequoia in fact accelerated their investments (Airbnb, Whatsapp etc.) to take advantage of the downturn! Most VCs, after waiting for a couple months, also jumped in. The same might play out this time as well. We believe VCs are waiting for market volatility to drop before jumping in. Everyone has a ton of dry powder and is waiting for some certainty before getting back to normal.
As they say, slowdown depends on the type of investor. Some double down with their investments, some sit on the side-lines. Which one are you?