Startup and emerging tech companies are entering what could be the most challenging business climate in more than a decade. As a founder, you need stability to weather the storm. This is particularly true when looking at the lifeblood of innovation and emerging tech–funding.
The venture capital and financing market for tech companies has boomed for many years, with early-stage companies raising significant sums of money and scaling at an unprecedented pace. As inflation soars, GDP growth slows, and the economy flirts with a recession, much of that funding is destined to become far more difficult to obtain. The New York Times recently reported that investments in tech startups fell a staggering 23% in just the past 3 months.
Risk-based capital is still non-existent for most early-stage companies that lack a proven track record, proven technology/process, and/or an established customer base. My company, Edge Management, raises capital for emerging tech companies, and the primary challenge we see from our clients is where to find their next round of funding once they have exhausted “friends and family” options.”
4 Strategies for Your Business Prepare for a Recession
As you gear up and perhaps retool your business to weather a recession or at least a difficult funding environment, here are strategies to help you emerge stronger on the other side.
#1 Know That Emerging Areas of Tech Could Be Hit Harder
You need to have your eyes wide open about what could be coming if the economy experiences a downturn. Some areas of tech are more vulnerable than others, and that is particularly true for emerging areas of tech such as green tech, clean tech, and other sectors where business models have not quite been proven from a financial standpoint yet.
There will naturally be a bias among investors and lenders towards business models that are proven, sustainable, and profitable. If your company is in a higher-risk sector, more conservative financial planning is crucial.
#2 Know Your Numbers
What’s unique about the current economic climate is that after a booming economy that has lasted more than a decade, you may have never experienced the difficulties approaching. This will require retooling how you think about growth strategy and resource investment.
You will need to know your numbers inside and out. The numbers you should be tracking are:
- Burn rate
- Cash-flow runway
- Options for increasing runway
- Cost for increasing runway
As we’ll see in the next section, economic uncertainty can also present opportunities for significant growth, but it can only happen when you don’t overextend through uncalculated risk-taking. All decisions need to be carefully modeled and budgeted for worst-case scenario strategies and contingency plans.
#3 Prepare for Opportunities
While recessions often have negative connotations, the truth is that challenging environments almost always present opportunities for a company to grow. The problem is that most companies are unable to take advantage of a bear market because they did not prepare properly at the onset of the recession, and so they are not operating from a position of strength.
What you need to remember is that during a bear market or recession, market share is up for grabs at some of the cheapest prices it ever will be.
Whether it’s marketing, talent acquisition, or operations, most of your competitors are going to be pulling back. By increasing your investment in these areas in a down economy, it is by far the easiest time to outpace the competition for a much lower cost than in a bull market. But you need to have capital, which is what we’ll cover next.
#4 Raising Capital Is Going to Be Very Difficult (You Need a Plan)
Coming out of a period where early-stage startups in just about every niche of technology were raising large amounts of money at sky-high valuations in very early rounds, the fundraising climate changes dramatically in a down market. And the signs are already showing in the capital markets. Whereas previously, a startup with a great pitch and at the right time could quickly raise money off of a deck, you now will need a very well thought out fundraising strategy with contingency plans and alternate sources of capital.
In previous economic declines, many tech companies also turned to raise debt as an alternative to equity. While the cost is lower, the vetting is often more stringent. However, it can also allow you to avoid diluting your own stock. This is where being in an emerging sector of tech can complicate your funding challenges. High-risk areas of technology such as clean tech and green tech notoriously have trouble raising capital in a down market due to unproven business models and financial uncertainty.
Raising equity has been the only option for most companies in this market segment. And as interest rates increase, even more established early-stage companies are faced with limited options for debt. To continue growth, early-stage companies need to de-risk their business models, raise debt from nontraditional sources, or continue to raise equity, even if their businesses pose less risk to traditional equity lenders.
Emerging tech companies in high-risk sectors need to take steps to position themselves favorably for a debt raise before fundraising challenges begin. One tool that many employ, especially in areas such as green and clean tech, is the use of Performance Guarantee Insurance (PGI) to lower their cost of debt. By essentially “insuring” your business model, you can lower your perceived risk in the eyes of lenders and become a more attractive funding target, sometimes even at a lower interest rate.
In the current VC/interest environment, having the backing of major insurance companies becomes even more appealing for companies seeking funding. Although the funding landscape has drastically changed/slowed in the last few months, our clients are pushing forward on projects at full speed, knowing they will have access to the capital they need.
With all of that said, it’s not to say that raising equity is not possible in a bear market. While far fewer companies are funded, the ones with an excellent team can often still secure funding. The key lies in having an excellent business model and team leading it.
How to Prepare Your Startup for a Recession FAQ
Q: If I’m a bootstrapped company, how should I prepare for an economic downturn?
A: For bootstrapped companies, the numbers that you must know are even more important. Not only because you need to know what your burn rate and current cash runway is, but also because if you encounter a cash crunch, a need to raise either debt or equity may arise.
Q: What if I’m in the middle of fundraising? How should I adjust my approach?
A: Flexibility is key when raising capital. For example, you may currently be raising equity, but as we enter a very unstable environment for equity raises, you need to have the flexibility to consider switching to a debt deal or even a creative financing strategy such as the performance guarantee insurance mentioned above.
Q: How can I protect my startup in an economic downturn besides cutting staff?
A: Maintaining cash reserves, and raising capital to bolster those reserves before the economy deteriorates further, is the best way to put a tech company in a position to weather economic uncertainty.
Q: If there’s a recession, how long will it be? Is it better to prepare for a worst-case scenario?
A: Most data shows recessions to last 12-18 months on average. Your financial strategy should always be to prepare for the worst-case scenario and maintain a conservative cash position. It’s easiest to raise capital when you aren’t in a significant cash crunch.
Recessions Don’t Need to Spell Downturn
While the broader global economy could well see a pullback in the coming months, every economic cycle has winners and losers– and there is plenty of capital to be raised. Which side of that you end up on is not determined by luck or by a brilliant product but often by the strategic decisions that you make in a few key areas: funding, positioning, proactive decision-making, and also calculated risk-taking.
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