Startups: Don’t Build A House Of Cards During A Market In Flux
The Future of Innovation is Global. We discuss it here.
Adapted from a piece originally published on my Forbes column here.
A key topic in startups today is valuations and funding. The public markets for technology stocks have been in freefall. The Nasdaq Composite index is down 30% this year. Some sectors like fintech have fared much worse. Square, Paypal and Coinbase are down 50, 60 and 75% respectively (as at end of may). Tiger is down over 50%.
This is against the backdrop of record venture capital raises and startup funding last year. 2021 saw $621b in venture capital funding, more than double 2020. A record 959 new unicorns were minted – a 61% increase relative to 2020.
The problem is that the current venture modus operandi has been blitzscaling – sacrificing efficiency for speed: where it is ok to sacrifice unit economics in service of growth and to have an unsustainable cost structure and cash burn in service of becoming a unicorn.
This has worked in the go-go days of 2021, and driven our collective merry-go-round of capital funding. More funding drives more spending on growth, which in turn drives revenue. It also drives a need for more venture capital. New rounds were raised at higher valuations, and so on.
Until the record started to skip.
When public market valuations come down, as they have for many recent IPOs, the context changes. All but one 2021 technology IPOs are down. And because the public markets are part of the capital supply chain, this will affect every stage of startup funding.
In my last newsletter, I shared the litany of Black Swan memos with advice on navigating the crisis (see here, here, here or here and promised my own take.
Well, what should startups do now?
If you read this newsletter, or my book, you won’t be surprised that my answer is that startups should be camels.
Camels are animals that can survive in the world’s harshest environments. But when times are good, they can guzzle water faster than any other animal and sprint across the desert. In short: they thrive when times are good but survive when times are bad.
In this piece I offer a few pieces of tactical advice for founders looking to navigate the situation.
Lesson 1: Focus on a foundation of sustainable unit economics
As the old adage goes, startups are not companies. They are projects in search of a business model.
That’s why finding the business model as fast as possible is so critical. And there is one way to know whether the business model works, at its simplest core: unit economics. Camels build on a foundation of sustainable unit economics. This means that they don’t scale revenue or customers until they have that approach nailed down. Startups have a strong handle on metrics like LTV/CAC, churn and renewals, and sales efficiency (depending on business model) and the levers they can toggle to adjust.
As we navigate the current crisis, the focus should be on ensuring the core piece of the business model works. Nail unit economics. Figure out growth after that.
Lesson 2: Manage cash burn
The default for a startup should not be venture capital. It should be building a business that can grow and succeed over time.
Venture capital is a tool in service of that goal, and used for a particular purpose – accelerate product development, make an acquisition, turbocharge customer acquisition when times are good, etc.
As we’ve seen, venture capital rounds are getting smaller (and at lower valuations). The right move is to manage cash burn. This doesn’t mean be profitable tomorrow. But it does mean having a strong understanding about the levers it takes to get there over time.
Fortunately, there is still capital out there for the best startups. And for those that were lucky enough to raise big rounds last year, they enjoy a nice war chest today.
Startups should play to win (not just to survive), but do it on a foundation that gives optionality to get to profitability if need be down the line.
Lesson 3: Keep a long-term outlook
Startups should keep a long-term view. Building a startup into an enduring business is not an overnight affair. It requires the foundation (points one and two) and long-term execution. When they raise, camels don’t optimize only for valuation. They think about what the right amount of cash (and dilution) is required to stay disciplined. They think about what the right valuation is for them that sets them up to raise in the future (should they want/need to) at a price that is attractive for all.
The last two years were dominated by SPAC mania, and the lure of easy riches. Nearly all SPACs are down from their IPO prices with the SPAC index tumbling 23% in January, and far more since then. Many of these companies were listed too early in their journeys. And in any event, being public is merely a milestone, not the objective in itself.
While the road may be bumpier, the right move is to keep looking at both the short-term to manage current headwinds, but the horizon.
Where we go from here
Camels survive. They also succeed and scale. They are the more reliable path to becoming a unicorn, in any macroeconomic context.
The news is dominated by many events that could shock the system – from war in Ukraine to Chinese deleveraging to run-away inflation. Technological transformation will be a long-term trend, and will show resilience to these short-term shocks. But each individual startup must be resilient if they want to navigate the turbulence.
Now is the moment to think like camels.
PS: Fun to see Consuelo Valarde (SV Latam) discuss Camels live on Bloomberg.