Building a startup through a “downturn”: The Essentials

Having been a builder and operator in software between 2011 and 2021, I’ve seen multiple ups and downs. Whether it be the tail end of the infamous 2008 financial crisis, the 2015 market sell off, the first real “at scale” 2018 cryptocurrency crash, and the COVID-19 pandemic in early 2020 — it’s always important to turn back to the basics and remind yourself that sound startup building principles are your best friend.

Based on many conversations I’ve had with operators who preceded me and through my own experience, I can unequivocally say that H2 2020 to H1 2022 was the most superficial version of building a company over the last 20 years. Let’s get back to reality!

Now that we are headed into another downturn, and a subsequent “return to normal”, I figured I’d lay out some of the core principles that have served startups well for decades, and should quite frankly be the norm. At 186 Ventures, we feel it’s extremely important to be candid with all of the founders we support. Now is the time to get back to the fundamentals and immediately block out the noise.

1. Avoid distractions and confirm your top 1–2 priorities for the year

Succinct goal setting is always important, but it is in order of magnitude more important when your industry is impacted by all sorts of headwinds, both on a macro and micro scale. Even if things feel “safe” today, distill your company’s primary objectives (e.g. OKRs) down to one or two goals (literally one or two, nothing else). It minimizes the probability of focusing on the wrong activities.

This helps make it crystal clear to you and your team whether or not the company is succeeding, and thus the need for adjustments across the board will become clearer and more straightforward.

2. Double down on customer conversations

Becoming the absolute best at understanding the ins and outs around what motivates your end user and how their respective thinking on the problems you solve is one of the biggest opportunities to capitalize on during a downturn. Your customers or users are also likely facing a multitude of issues as a result of the macro circumstances. Helping them through these issues, whenever possible, via your product or service, can go a long way to building customer longevity.

Think about what frameworks or checks and balances you can implement to level up your customer development game and hold your team accountable.

3. Cut costs deeply once, preserve maximum morale

There is nothing harder than having to tell people who have entrusted their careers and livelihood to you that they no longer have a job. Having to lay off staff is an inevitable part of every business because typically labor is the biggest expense, and downturns usually amplify this reality. I’ve been through having to do this first hand and can thoroughly empathize.

You owe it to your team and shareholders to keep the lights on and live to see another day– assuming this is what shareholders/founders want to do. If you think you need to reduce burn by 20 percent, reduce it by 40 percent. Because there are people’s lives involved, as a CEO and founder, you will subconsciously try to believe that you need to keep someone on staff who is not mission critical. The reality is that if your company continues to feel the pains of the downturn for an extended period of time, you will more likely than not end up laying them off at a subsequent point in the future anyways. The goal here is to cut costs quickly and once.

Because of how much of a hit cutting costs and headcount can have on morale, try to do it only once. Recovering from one series of layoffs is much easier to do than multiple rounds. When you need to cut, it is essential that you cut deep.

4. Focus on culture

It is easy to underestimate the importance of building a strong culture and the benefits a positive environment has on your people and the startup as a whole. In most cases, it is not something you can grasp, like a set of revenue goals or a financial spreadsheet. A lot of what makes culture is the intangibles — the core values by which everyone lives and works, the relationships that exist between team members in and outside of the workplace, and the level of care that people genuinely lend to each other — you cannot build these things overnight.

You must always be on the offensive, in good times and in bad, with building the office culture because you will especially need it during tough times. If you were spending five hours a week emphasizing “the why” employees work at your company, you should start spending 10 hours a week moving forward. Make a meaningful, quantifiable effort to demonstrate to your team why it still makes sense to take the risk of remaining at your startup, even when the world seems upside down.

5. Raise what you need, think long-term, don’t dwell on the past

These last two principles are so incredibly important and usually have the biggest influence on the trajectory or failure/success of a startup. Whether you’re raising your first round of financing or a subsequent round, during a downturn you need to be super practical about getting the job done. The job is keeping the lights on and giving your staff what they need to complete their work in a high quality manner. It is quite binary: you either raise the money you need or you don’t. The trajectory of your business will largely be determined by the result of this binary outcome.

Don’t look at what other companies have raised in the past and at what valuations they may have previously achieved. Whatever assumptions you previously made before a downturn need to be thrown out the window and you must objectively look at the white board with an empty canvas.

First, think hard about what you actually need in financing regardless of whether it is your first round or not. For example, the average seed round may have been $3m to $4m during 2021 and most of 2022, but this doesn’t mean your startup needs this amount of funding.

Second, think long term as it relates to what securing ample financing during a downturn can do for your company. It will set you apart from other startups that fail to raise funding and give you the ability to power forward. Therefore, if you thought you would be able to raise at a $30M post-money valuation six months ago, you may need to bite the bullet and raise at a $10M post-money valuation. Remember, each day is a day that your competition can win the attention of whatever VCs you may want to pitch because they have a more compelling fundraise offering, and as a consequence, you end up becoming less of a priority in the eyes of said VCs. I say all this as a former founder who has had to consider my own valuation and now as a VC considering others.

Third, as the founder, it is your job to minimize distraction. Raising capital is a distraction, even if you do a good job of guarding your team members from the process. Optimize for speed and time to close and get it done. A downturn is not the time to get fancy with trying to maximize every element of the funding terms, even if you believe you are a cream-of-crop company.

6. Be intentional about the investment syndicate

This last principle should apply when raising capital in any market condition. As we saw over the last two to three years, there was so much capital available that it was seemingly convenient to raise from a wide variety of sources to close faster, boost valuation, build up FOMO, and so on. During downturns, this is not as easy to do, and even if it is, avoid this at all costs.

On the one hand, you should raise funding to keep things moving, but you want to make sure you’re choosing partners and structuring your round to optimize for both short-term and long-term success. Use the downturn to your advantage by getting to know prospective investors and venture partners and be proactive with optimizing for the right partner over anything else. You may not get as “high” of a price by allowing one or two investors to be your lead, but you will be much better off than your competition by having investors who have enough skin and potential upside in the game and who care.

Few caveats to consider when digesting all of this:

1. These principles should be filtered down to the stage of the company you are running. I would argue that all of these apply to any size business, high growth or not, but some of these may apply more depending on the size of the organization, e.g. #3, cutting deep, is a lot harder and more irreversible to get right the higher your headcount/burn is.
2. To make the most use of these directives, start your reflection in a binary sense. Have you been picky with your valuation more or less before the downturn? If so, then flip the narrative now that we are in a downturn and don’t even think about optimizing for valuation until you receive a formal offer.
3. Management style has a lot to do with how you put a lot of this into practice. Communicating a lot of this to your team is as important as mentally buying into whether you’re going to do it. None of this is turnkey.