This week all portfolio founders of the Y Combinator got an email titled “Economic Downturn.” The startup accelerator advised them to “plan for the worst,” as well as suggested cutting their expenses, extending their runways, or focusing on raising money. As TechCrunch emphasizes, this letter is a signal that the global market teardown that caused the reduction of tech giants’ valuation, including Netflix and Shopify, has already reached the early-stage startups. AIN.Capital publishes the YC’s letter.

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:

  1. No one can predict how bad the economy will get, but things don’t look good.
  2. 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.
  3. 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.
  4. 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.
  5. 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 slow down will have a disproportionate impact on international companies, asset heavy companies, low margin companies, hardtech, and other companies with high burn and long time to revenue.

Note that the numbers of meetings investors take don’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.

  1. 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 fundraises will be much more difficult.
  2. 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.
  3. 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.
  4. 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.
  5. For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn

Best,

YC

What “Economic Downturn” are they talking about?

Last year was full of sky-high valuations and funding rounds, and the trends have changed to the opposite in 2022 when the global investment industry is slowing down. Valuation cuts, a slowdown in funding, and a general economic downturn all around the globe are caused by exploding inflation, continuing the pandemic, as well as geopolitical tensions because of Russia’s invasion of Ukraine. For example, amid the war and sanctions on the part of the US and its European allies, the S&P 500 saw its most drastic one-day drop since May 2020, according to Time. There is no exact answer if the market is going to crash, Time writes, but the war will definitely further affect the global economy dramatically.