Why do startups fail? On one level, the answer is pretty simple. “Most startups fail because they run out of cash and can’t raise more,” says Tom Eisenmann, a professor at Harvard Business School.
“And then you have to ask, ‘Why?’”
But Covid-19 has introduced a new reason that many startups are suddenly at risk of failing: plunging consumer demand and the prospect of an extremely sharp and possibly very protracted global recession. Venture capital firms are warning their portfolio companies about the coming economic climate and how to survive it. Quartz reviewed their advice and drew on some lessons of past crises, to help startups respond to this challenging context.
Startup funding dipped during the Great Recession, as did valuations. And deals that did happen took longer, according to an analysis from Pitchbook.
In a March 13 blog post on Medium, Flybridge Capital, a seed-stage venture capital firm based in New York and Boston advised:
If you’re in the midst of a financing process, stop negotiating and close it. If you’re embarking on a financing process, consider whether you can pull back and wait and/or be prepared to take a suboptimal deal.
The good news is that the fundraising dip likely won’t last forever. By the first quarter of 2010, the number of venture capital deals had surpassed its post-dotcom, pre-recession peak.
The current environment is different, because venture capital deals typically rely on in-person interaction. But even that could change. If startups can manage for the next year, the climate will likely improve.
“Your burn rate is the speed at which your cash balance is going down,” Fred Wilson of Union Square Ventures explains in his post on the topic. It’s perhaps the single most important metric for startups, at least in hard times.
The impact of the coronavirus crisis means it’s time to recalculate it, says Eric Paley of Founder Collective:
The venture capital firm Sequoia adds in a Medium post:
Do you really have as much runway as you think? Could you withstand a few poor quarters if the economy sputters? Have you made contingency plans? Where could you trim expenses without fundamentally hurting the business? Ask these questions now to avoid potentially painful future consequences.
Assume you need to cut costs 20%. Why 20%? Because human instinct is to be optimistic and, besides, cost-cutting sucks and so you’d rather not do it. Instead, you hope for the best. Experience suggests you should cut now, cut more deeply than you think you should, learn to do more with less, and be ready to “survive and advance.”
Sequoia suggests marketing as one place to look, in part because lowered demand could mean a lower lifetime value for newer customers.
You’re probably not communicating enough, says Flybridge:
The single biggest problem in communication is the illusion that it has taken place. You may think you’re communicating well with your team, but you need to aim for over-communicating. They should be on the verge of tired of hearing from you. A daily update note that is personal, authentic and informative is warranted. During uncertain times like this, your team wants to hear from you and wants to know that you’re taking decisive actions. Don’t hide bad news and be comfortable with the “worse before better” effect (i.e., the more transparent you are, the worse things are going to initially feel).
Further reading: The work from home tips we shared with our staff
Further viewing: Remote Control, a Quartz at Work (from home) workshop about communicating better, staying focused, and making a smooth transition to working at home
Startups also need to find a way to stay in close contact with customers they might otherwise visit in person, says Ajay Agrawal, a professor at the University of Toronto and founder of Creative Destruction Lab, a startup accelerator. This was a theme at a recent CDL meeting in Oxford, along with discussion about management and conserving capital.
Successful startups will need to “develop an online routine for connecting with customers,” says Agrawal, both to cement the relationship and to solicit product feedback even in a chaotic time.
Early-stage startups with fewer than a dozen employees and one office where they all work together “often don’t have great role clarity,” says Agrawal. That’s usually ok. The team can easily coordinate in person so that “everyone just does what needs to get done.” The advice that founders and mentors were sharing at the recent CDL session was to be more explicit about role clarity. Startups will have to define “who’s providing what, whose input is needed, who needs to sign off on what,” he says, even if that normally wouldn’t happen until a later stage.
Great companies do get founded even in terrible economic conditions, as Michael Seibel of YCombinator noted in an interview with Marketplace:
When we look in the past, a number of our most successful startups were actually started either right before, during or immediately after the 2008 crisis. These are companies like Airbnb, Stripe, Mixpanel and PagerDuty. What we see they all have in common is that they’re software companies with small teams, and literally all they had to do to get up and running was build their software product, give it to customers, and iterate and make it better. We believe that companies that look like that right now will have a large advantage in getting some initial users, getting their product out to the world, and be ready for when the economy comes back.
Sequoia advises the same thing:
Many of the most iconic companies were forged and shaped during difficult times. We partnered with Cisco shortly after Black Monday in 1987. Google and PayPal soldiered through the aftermath of the dot-com bust. More recently, Airbnb, Square, and Stripe were founded in the midst of the Global Financial Crisis. Constraints focus the mind and provide fertile ground for creativity.
Now that Covid-19 is creating constraints we’ve never seen before, we can only presume that some brilliant new business ideas will eventually come out of it.
Dan Kopf contributed to this article.