Startup fundraising, after a massive bull run in 2021, is in an obvious downturn. Public markets globally, are in one of their worst bear run phases, which has had a direct impact on the ability of investors to take larger risks. Saying there is a startup fundraising crunch at the moment, will be an understatement to actual market conditions. And while funding at seed and angel stage still goes on, it is startups who are raising larger sums — Series B/C and later — facing pressure.
Last week Techcrunch reported that Y Combinator, a renowned Silicon Valley startup accelerator, is advising its portfolio founders to “plan for the worst” as startups across the globe scramble to navigate a sharp reversal after a 13-year bull run in funding and valuations.
The seed-stage investment firm — whose early backings include investments in Dropbox, Coinbase, Airbnb, and Reddit — sent out a letter urging startup founders to cut their expenses and focus on extending their runways within the next 30 days. For those who don’t have the runway to “reach default alive,” YC is strongly suggesting that they consider raising money sooner than later. The email said a “large number” of its portfolio companies have reached out for advice on how to react to the current economic climate and stuttering stock values.
“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,” the firm said in the letter, titled “Economic Downturn.”
The note from YC, which backs hundreds of young startups a year, is a signal that the market teardown has significantly slashed the value of a large number of tech companies, including giants such as Shopify and Netflix, in recent weeks is now starting to trickle down to the early-stage startups’ universe.
- Y Combinator told startup founders that “things don’t look good” in public markets right now.
- The California-based startup incubator gave them 8 things to do in a downturn.
- Among them is to play it safe, “plan for the worst,” and just stay alive.
TechCrunch obtained the letter YC sent to its portfolio founders this week.
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.
- 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.
- 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.
- 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.
- 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.
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 slowdown will have a disproportionate impact on international companies, asset-heavy companies, low-margin companies, hard tech, and other companies with high burn and a long time to revenue. (Note that the number of meetings investors take doesn’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.)
- 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 fundraising will be much more difficult.
- 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.
- 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.
- 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.
- For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn.
“PS: 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. Also, remember you can always reach out to your group partners,” the letter adds.
Y Combinator has advised it’s portfolio investment companies’ founders to cut costs and plan smartly, in order to be prepared to survive through this economic downturn. Warning that the funding crunch is expected to only get worse in coming times, and newer startups that haven’t necessarily found a product/market fit should not expect any new funding to come their way and therefore plan their expenses accordingly.
The letter further sheds light on how the competition among VC firms pans out in situations of economic downturn. Since some VC funds have a tough time bringing in new capital in the first place, and their limited partners (LPs, investors of a VC fund) expect safer, more on-point moves, most VCs slow down new investments. Many startups have had mass layoffs in a bid to cut costs, and funding rounds have significantly decreased in size. Recently Business Insider reported that some economists have warned the US may be heading into another recession, albeit a mini one that will likely be very different than the last two. Experts previously told Insider that a looming recession would be more like a correction to compensate for months of large amounts of spending.