Startups are a microcosm of the economy and we can observe that things are changing quickly towards a recession footing. The effects of inflation on valuations are readily apparent, but we also see that things were too good to be true and investors and late stage companies exploited it.
Everyone looks like a genius when things are going well, but as it turns out, that wasn’t very durable.
How should we think about running a startup during a recession?
- Salaries are the largest cost on a startup’s balance sheet and the first to be cut back with hiring freezes or layoffs
- Selling to other startups will have greater churn as companies run out of capital and are unable to raise money
- Efficiency is more valuable than pure growth (as evidenced by falling revenue multiples in public markets)
Links to this note
Founders Should Write the Check for All Expenses
For as long as possible, in an early-stage startup, one of the founders should write the check for any expenses of the company. That includes payroll, vendors, SaaS subscriptions, professional services, and how much you’re paying accountants and bookkeepers (whom you may incorrectly think are looking out for the company’s cash).
Inflation Causes Downward Pressure on Startup Valuations
As inflation rises there will be a tightening of money supply and higher interest rates to control it. This causes a repricing of assets and, in particular, high-growth tech stocks. The median public company software valuations dropped from 12x forward revenue to 5x or less—an almost 60% decline.
Probability of a Recession (2022 Q3)
The probability of a recession in the near term based on estimates from economists at investment banks.
CEO Lifespans Decrease 1.5 Years in a Downturn and They Look Older
In a paper CEO Stress, Aging, and Death, the authors studied the effects of managerial stress on lifespan and visible signs of aging. They found that CEOs' lifespan decreased by 1.5 years in response to an industry wide downturn. They also look older than there age by one year over the decade following a ‘distress shock’ like the Great Recession—James Donald, CEO of Starbucks, looked 3-5 years older than his biological age base on pictures from 2004 to 2010.
Many Startups Will Run Out of Cash Starting End of 2023
In Startup Decoupling & Reckoning by Elad Gil, the author lays out the situation many mid-to-late stage startups will be in starting at the end of 2024. Companies raise capital for 2-4 years of runway. Valuations have risen sharply compared to public markets. Raising money will be more difficult as startups that don’t have product-market fit will not hit key milestones relative to their valuation.
Revenue Multiples Fell from 24x in 2021 to 10x in 2022
Enterprise Value (EV) to Next Twelve Month (NTM) revenue multiples in public markets for SaaS businesses rose sharply from 2019 to 2021 up to as high as 24x. Now, those multiples are falling below pre-pandemic levels to 10x. This has major implications for retail investors, VCs, and running a startup during a recession.
Burn Multiples Are a Way of Managing Growth Efficiently
A burn multiple is the amount of cash burned by annual recurring revenue (ARR). For example, if a company burns $10MM to add $30MM ARR the burn multiple is 3.0x. Higher burn multiples are worse and imply the company will run out of money faster. This is a better measure of overall efficiency compared to LTV/CAC because it encompasses all costs (burn).
How Long Will a Recession Last?
We are probably in a recession already, but we can’t know for sure for another quarter or so. With inflation on the rise and interest-rate hikes making less money available, it will be some time before things grow again.
There is a long list of reasons that a startup to fail, but running out of money is high among them. A common piece of advice for early startups is to make rapid progress towards “default alive” as in, running the business on revenue rather than relying on outside investment.
There have been 115 tech companies with layoffs since April 2022 and a steep increase in May.
Outline for my annual essay about things I learned and reflections for the year.
How Much to Pay Yourself as an Early-Stage Founder
This question comes up a lot from founders starting a company and raising a seed round—how much should you pay yourself?
Startup Funding Fell 67% in 2022
In 2022, startup funding fell dramatically—down 67% year over year. Late stage funding took the largest hit (down 67%), but early stage (series A and B) also dropped 59%. Seed stage investments were down 37%.