The economy is enjoying a spectacular run. The S&P 500’s bull market approaches its 11th birthday in March, and many younger investors have never seen a bear. But all good things come to an end — and ominous clouds are already gathering.
Key segments of the US yield curve inverted at the end of January — an event that historically precedes recession. The coronavirus has seized the world’s second-largest economy and threatens economic trade worldwide. These are just the latest signals that indicate we may soon be in for turbulent economic waters.
As a venture capitalist (VC) who works with startups, I’ve been anticipating a downturn for a while. My company is already preparing by making sure we have cash on hand, pulling back on investments, and scrupulously vetting companies.
But a recession doesn’t have to mean doom and gloom. It can create opportunities, too. In fact, we like to think of a recession as a reset — a chance to make sure we’re on solid footing, trimming the fat, and identifying new possibilities.
Warren Buffet presciently advised in the depths of the 2008 Great Recession, “be greedy when others are fearful,” and we’ve taken his words to heart. Turbulent times can be a great opportunity to make long-term investments in high-quality companies.
I understand a recession can seem a lot scarier from the vantage point of entrepreneurs. However, as someone who successfully steered ventures through the dot-com bust and the 2008 financial crisis, I can tell you a downturn in the markets doesn’t have to herald the death of your company. In fact, it can present an opportunity to level up by forcing you to get your house in order.
Here are some steps startups can take to not only survive but thrive (and even attract investors) in a down market.
Be laser focused on profitability
“Spend fast to grow fast” was last decade’s mantra, with investors driving money-losing unicorns like Uber, Lyft, and WeWork to multi-billion-dollar valuations. But the markets are already souring on companies that seek growth for growth’s sake. Making a profit is back in style again.
That trend is bound to continue through a downturn, as investors shed risk and seek the comfort of returns. Your pitch deck isn’t going to lure many bites if your business has multitudes of users but no profit-generating customers.
Besides, a profit model that works can keep your company afloat as VCs, angel investors, and banks rein in their investment funding.
Keep a sharp eye on spending
On a related note, startup cash flows can trickle slowly at the best of times, much less during a recession. But you can still squeeze the most out of what you’ve got. Capital efficiency is the first measure I look for as an investor, even more so in a downturn. It’s a good indication of how you’re going to spend the money I give you, and how you run your business.
Tracking expenses is always important, but a recession can make fat-trimming essential to continuing innovation. That means maintaining enough cash to keep ideas flowing through the R&D pipeline rather than just keeping the lights on.
Don’t forget about your people
Companies often overlook morale in a downturn — cutting back on perks like free-flowing single-origin coffee, kombucha, and Christmas parties. But your team is crucial to weathering a storm. Your people need you to provide more than strong leadership and support, they need to know you have a plan they can buy into.
Be as transparent as you can be about your company’s fortunes, the challenges that lie ahead, and how you plan to emerge from rough waters.
Think like an investor
As economic storm clouds gather, I’m looking to invest in companies with good mergers and acquisitions (M&A) potential that have applications in relatively recession-proof areas like gaming, entertainment, education, vices, and health. Cyber security and business automation technologies like data analytics and AI are also a strong bet, no matter what the market is doing.
For entrepreneurs, this may be the perfect time to enter a new market, or look for applications, in these sectors. Downturns provide opportunities to make acquisitions or develop technologies and business streams for cheap.
As bigger companies retreat to focus on their core offerings, ask yourself if you can innovate in the spaces they vacate. Can you scoop up talent that previously would have cost a premium and build a better team? Can you acquire smaller companies or new technologies at bargain rates — value purchases that can propel your business to a higher level? Any one of these avenues may open up pathways to profitability that weren’t previously available.
Obviously, recessions can cause pain and leave casualties. We saw this when the dot-com bubble burst at the start of the millennium, wiping out more than 75 percent of the Nasdaq’s value. We see similar culling on a smaller scale whenever a new sector emerges with significant hype. For example, nearly 2000 cryptocurrencies have failed so far and the cannabis space is currently in the midst of a similar reality check. But recessions aren’t all bad. If anything, they’re a test of integrity that separates the wheat from the chaff.
Above all, optimism is key to building a business in both good times and bad. Recessions are inevitable, but they’re also temporary. Companies on solid footing and with long-term vision will make it through, and may even be stronger for it.