Updated: Aug 3, 2022
Everyone is asking the same question in the tech industry right now: Are we in an economic downturn? From private conversations to public memos, the industry is bracing for a correction. But while we’re all talking about what’s to come, a look into the past could help guide startups and investors alike through this potentially rocky time.
In May 2022, startup accelerator Y Combinator shared a warning for investors and startups: a looming economic downturn could impact startup investment, right on the heels of VC funding falling quarter over quarter for the first time in Q1 2022. Y Combinator and other investment firms have other good reasons to predict the worst. SoftBank announced a loss of $27.7 billion in its Vision Fund, which focuses on growth capital and social impact investments. Tech stocks like Netflix and Meta are dropping. Inflation and other market factors like the war in Ukraine, global societal unrest due to rising costs, and severely diminished global food production create overall economic instability.
On the other hand, VCs have raised the most money in the last two years than ever before with new funds with the new funds needing to deploy capital and build their portfolios in the coming months. As Eric Hippeau, a managing partner at New York-based VC firm Lerer Hippeau, said this about the 2020 recession: “The VC game is a long game. It's a multiyear game, and a recession should not really have a major impact on the future of a fund or its portfolio companies."
What is the way forward for angel investors, VCs, and startup founders then? To figure this out, we must look to the past. Recessions and significant downturns in 2008 and 2019 can help us understand what the entire sector can do to support founders, keep startups alive, and move forward to a robust market again.
Historically, startups have found it more challenging to raise money during a recession. In the 2008 recession, VC investment in startups decreased. Startups saw a decline in valuations and the average time between investments increased. In 2009, The New York Times reported on the speed with which typically risk-tolerant angel investors were fleeing the startup market, citing an Angel Capital Association survey that said half of their respondents were investing less than anticipated that year.
A similar slump was observed during the 2019-2020 recession, with deal value reducing in 2019 and the number of deals slowing in 2020. However, the Black Swan that was the 2020 venture scene turned tech companies that were seen as nice-to-haves into essentials and was a catalyst for the billions of dollars committed to investing in founders of color. Without those factors, it’s easy to see why the alarm has been sounded this time.
In an economic downturn, investors are looking for companies with a clear path to profit. Dealmaking becomes more selective as investors focus on those businesses that have strong traction and revenue. At the same time, for those underrepresented founders who struggle to raise capital in the best of circumstances, a recession can mean they will be completely ignored by investors. In a study of VC-backed startups from 2013-2017, researchers found that more than 77% of startups supported by VCs were led by white founders. While startup investment in Black, Latinx, and women founders increased in 2021, the funding for these underrepresented founders is now stalled or sliding backwards. These groups, along with founders from the global south - particularly in Latin America and Africa - are the most vulnerable to the economic downturn and related shifts in startup investment.
So, what to do? The good news is that both startup founders and investors can make some moves now to protect their businesses and investments.
Startup founders can take three steps to help recession-proof their businesses:
Get ready for changes in fundraising. This is the time to prioritize getting cash into your business. Focus on revenue-generating efforts and customers who can pay upfront, while also working with your current investors to understand their shifting priorities and funding cycles.
Look into mergers and acquisitions. While not every startup is ready to be acquired or to merge with another company, bigger companies have a history of maintaining or increasing acquisitions during a downturn. In 2008, Microsoft, Oracle, and Amazon acquired more companies during the recession than before or after.
Shore up your business fundamentals. Now is the time to pull out all your business planning and strategy skills. Review your cash on hand and cash burn expectations over the next 24 months. Conducting scenario planning sessions can help founders understand different ways to respond to crises depending on the various factors impacting the economy. Startups are also often faced with the hard decision to conduct layoffs during economic downturns. Plan for these potential situations so you’re ready if the time comes.
Investors have a key role to play in supporting the startup sector. Venture-backed companies represent 41% of U.S. market capitalization. In the first quarter of 2022 alone, angel investments globally accounted for $10.3 billion, and since 2020 accounts for $60.7 billion. It’s obvious that investors hold power and can greatly influence how founders and startups rebound from a global economic downturn.
Be intentional about your investment pipeline and who is at the table. From historical and ongoing divestment in underrepresented founders to a lack of diversity in VC itself, there’s a lot of room for VCs and angel investors alike to support founders of color and immigrants who may be hit the hardest with viable businesses to help them survive a downturn. Understanding and taking action against unconscious biases in investment can lead to increased funding for underrepresented founders that can go a long way towards their recovery and future success.
Remember that startup investment is a long-term investment. Investors should know from previous experiences with recessions and downturns that investments can rebound over time and are meant to be long-term. Startups and other alternative investments are unknown entities, so they aren’t automatically volatile because of the market. Diversifying your portfolio now can help you achieve future rebounds.
Remain transparent with your investees. Founders in your portfolio will only benefit from your honesty and transparency about your ability to provide funding now and over the next few years. Share your insights and your planning so that founders have space to make decisions for themselves and their businesses accordingly.
No one can predict what this economic downturn will be like for the startup industry. What investors can do is to shore up their investment processes with an eye to diversification and founder support. At Fundr, we set out to help diversify and protect startup investments by creating a deep, AI-driven methodology to vet startups that are available for investment on our platform. Our smart algorithm evaluates startups on 90 pieces of data, removing bias and helping investors to simplify the decision process. The Fundr Score™ surfaces and ranks the best startups you may have overlooked. And, with our latest SPV offering, we now provide multiple ways for investors to make the best decisions about their portfolios.
Fundr is committed to strengthening the investment ecosystem by providing access and opportunity to both startups and investors. Ready to start investing with us? Reach out to us at firstname.lastname@example.org.