Peak Performance #31 | Leading Through a Downturn
Recessions, their impact on startups, and how to lead through it.
It's increasingly looking like the US, and perhaps the globe, is entering a recession1. The signs are everywhere:
Financial Markets are tumbling, including crypto
Growth stage tech companies are executing widespread preemptive layoffs
Valuation Multiples2 for SaaS companies have collapsed (median multiple dropped from ~15 to 5.6, a 60%+ drop).
Many people smarter than I am have analyzed how we got here and why a recession is likely happening. If you're a founder or work with founders, consider the following two resources required listening for understanding how we got here and how to operate through the upcoming downturn:
I’m so adamant that you listen to those resources that the most I will do is bury a partial explanation in the footnotes3. Read that if you’d like, and then make the time to listen to both of the above.
Recessions and Startups
If you’re a founder, a recession will be the single biggest macroeconomic driver of your business over the coming months and years. Here are a few ways your business is likely to be affected.
Growth
Recessions are characterized by a general reduction in spending. This tends to start with consumers and cascade to businesses, though many businesses will reduce spending in anticipation of a more challenging macroeconomic environment.
If you lead a B2C startup, recessions require you fight harder for your growth. While periods of economic expansion come with relatively extravagant consumer spending, recessions bring about a more frugal consumer. Unfocused messaging and sloppy execution in sales and marketing are likely to see a marked decline in performance during a downturn, even for strategies that may have sufficed in periods of expansion. You will need to double down on channels and messaging that works while trimming the fat on those that are anything but excellent.
If you lead a B2B startup, you will also need to fight harder for growth. As consumer businesses struggle, their budgets tighten. They become less likely to make or continue investments in experimental solutions without a proven ROI, preferring to focus their limited budget on essential ROI drivers. This creates revenue challenges for B2B companies that serve those B2C companies, which causes them to tighten their budgets, which then affects B2B companies that serves those B2B companies. There is a cascade effect, and no one is completely isolated.
In addition to budgets tightening there’s also a chance that certain vulnerable segments of businesses fold (verticals that are hit particularly hard by the recession, startups). During downturns the more established the incumbent, the more stable they are as a customer, assuming that the driver of the recession doesn’t meaningfully impact their segment and that you are driving a clear ROI. Enterprise>Mid-Market>Startup in a downturn.
That being said, it can be challenging if not impossible to pivot upmarket quickly. This is not a recommendation to do so, but rather a recommendation to make an honest assessment of the risk presented in your current portfolio of customers and determine strategies to derisk the revenue side of your business.
Regardless of your business, expect that growing revenue will become more of a challenge.
Fundraising (Access to Capital)
As financial markets tumble, money flees to safer investment classes. Startups are not a safe investment.
As a result, funding is less available and more expensive during downturns. The bar for fundraising goes up. What once passed as good enough may be nowhere near good enough, good may be not good enough, and great may just get the job done. The valuation craze of the prior period is likely over. You will need better metrics to raise at lower valuations.
Fundraising will also likely take more time. Investors will prefer to do deeper diligence in order to derisk their investments as much as possible.
Hiring
The single biggest pro of a downturn is that hiring gets easier. This is a blessing for startups in particular.
We’re coming off of one of the most employee-friendly labor markets ever. As larger companies perform layoffs talent floods the market, adding much needed labor supply. This relieves pressure on salary and equity demands by new hires.
This has been a particularly challenging labor market for startups—numerous founders have cited talent looking for an autonomous startup lifestyle with FAANG salaries. That is likely to shift in the coming months and quarters. The advantage is likely to level, and potentially return to you as an employer.
All of this is covered at length in the two resources above. Listen to them. They may be the single best use of your time in the coming days.
Leading Through Wartime
In his book The Hard Thing About Hard Things, Ben Horowitz describes what it was like to build a business and navigate the downturn that was the dot-com crash of the early 2000’s. In it, he coined the term Peacetime CEO vs. Wartime CEO. Stop and read a short article on it here. Essential passages:
Peacetime in business means those times when a company has a large advantage vs. the competition in its core market, and its market is growing. In times of peace, the company can focus on expanding the market and reinforcing the company’s strengths.
In wartime, a company is fending off an imminent existential threat. Such a threat can come from a wide range of sources including competition, dramatic macro economic change, market change, supply chain change, and so forth. The great wartime CEO Andy Grove marvelously describes the forces that can take a company from peacetime to wartime in his book Only The Paranoid Survive.
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In peacetime, leaders must maximize and broaden the current opportunity. As a result, peacetime leaders employ techniques to encourage broad-based creativity and contribution across a diverse set of possible objectives. In wartime, by contrast, the company typically has a single bullet in the chamber and must, at all costs, hit the target. The company’s survival in wartime depends upon strict adherence and alignment to the mission.
In the event of a recession, things switch from peacetime to wartime. This isn’t actually that different from how early stage companies should operate, as you are always fighting for your right to a continued existence. Regardless, it may require some shifts in mentality from how you were operating before.
Here are some principles to consider as you navigate the upcoming months.
1. Don’t Panic
You will likely feel a sense of urgency as you consider what a downturn means for your business. Your inclination for action will kick in. That’s okay, AND also give yourself some time.
These things unfold over months and quarters, not days. Give yourself a few days (or weeks) to process, consider how this might affect your business, and determine the right action to take. Unless you’re in an extraordinarily rare bind, there’s no decision that you can’t afford to sleep on.
2. Don’t Rush, Don’t Wait
Once you know what you need to do, do it. Work to execute at a meaningful pace. Now is not the time to delay. Inspect and move through your own procrastination and avoidance quickly.
That being said, don’t sprint so quickly as to do things recklessly. Work quickly AND do it well. Don’t rush through and risk making a mistake.
3. Focus
Recessions can be a blessing, as they force you to get back to the essential. Many great businesses were built during a recession. Google, Amazon, Salesforce, Airbnb, Stripe, and Paypal, to name a few.
The key is to focus. Cut the fluff and return to the essential:
Revisit your mission and ensure all activities are aligned around moving that forward
Double down on your core ideal customer personas and solving their biggest painpoints
Focus on your core business and revenue drivers. Ensure every experiment you run is the most impactful experiment that you can be running at that time
Double down on messaging and marketing that works—ruthlessly cut that which doesn’t
Cut back on extraneous spending. Now may not be the time for free lunches and ping-pong tables
Double down on motivating your high performers and improving the performance of (or cutting) those who aren’t
The goals are simple:
Focus the company exclusively around moving your core business forward.
Extend your runway as much as possible. This includes bringing in some quick cash if that’s available to you. As mentioned by Craft Ventures above—if this lasts for 2 to 3 years, the dream is to not have to raise for 2 to 3 years. If you can’t get there, the goal is to have enough runway to get your business in as good of a position as possible to raise.
Finally, embrace candor. Get your team enrolled in the reality that you are operating in a downturn. Don’t hide it from them. Share with them your perspective on the current reality so they can understand why hiring may be frozen, spending limited, or they may be asked for extraordinary efforts at certain key moments. Air on the side of overcommunicating.
You may notice that nothing I listed above is any different from how a startup should be operating. This is why downturns can be a blessing. They create focus and force you to be a better leader and build a better business. Use this one as an opportunity to slow down, zoom out, and get really clear on what will move your business forward and what won’t.
Essential Resources
E80: Recession deep dive: VC psychology, macro risks, Tiger Global, predictions and more
Craft Ventures: Operating during a downturn
A Framework for Navigating Down Markets
P.S. You might notice that I didn’t send this email on Sunday as usual. I wanted to send it this Sunday, but didn’t get it to where I wanted to to be by then. It also felt too important to delay until next Sunday. So it came out today. As I said above: Don’t rush, don’t wait.
Technically speaking, a recession is often defined as two consecutive quarters of negative annualized GDP growth. GDP, or gross domestic product, is simply a measure of how much economic activity is happening. Per this definition, a recession means that for two consecutive quarters there is less economic activity at an annualized rate than the prior quarter.
While this is the most common technical definition, recessions tend to have many other causes and effects. They usually last much longer than two quarters and include reduced economic activity and growth for years.
Valuation multiples are how much you multiply a companies revenue by to get its valuation. A company that earns $100MM annually and is valued at $1B has a 10x multiple.
The shortest explanation I can provide: US interest rates have been at historic lows since the great financial crisis of 2008. In response to the pandemic, the US federal reserve printed unprecedented amounts of money in an attempt to stimulate the economy. This appears to have had two primary impacts:
Most of this new money flowed into financial markets, creating massive growth in stock prices and company valuations
Beginning in summer of 2021, inflation began to rise across most major global economies
In order to combat the inflation, the federal reserve is now starting to pull money out of the economy and raise interest rates. This has, for many reasons, led to a significant drop in asset prices as people flee out of the markets, away from risky assets and toward safer ones. This flight is expected to cascade into a general economic slowdown.