5 Ways Startups Can Prepare for a Recession
by Lou Shipley
Summary: Startups face unique challenges during economic downturns. They typically aren’t yet profitable and so are reliant on outside funding
—and therefore are especially exposed when macroeconomic conditions change. To make it through a recession, startup CEOs should hit the road and talk to customers. They should also focus on preserving their company culture and retaining top employees. And they need to do whatever they can to extend their runways—including taking on a line of credit.
With stocks down 20% from their highs, we are officially in a bear market. Many economists predict we will enter a recession in the next few quarters if we’re not in one already. What strategies and tactics should startup CEOs use to prepare for and survive a recession? I’ve spent the last three decades in the software industry, including three stints as CEO as well as serving on the boards of 10 private companies and as an advisor to many others. I’ve led or advised companies through the dotcom bubble bursting, the 2008 financial crisis, and the Covid recession. While every downturn is different, in my experience there are some essential steps that startups should take when the economic environment deteriorates.
Take steps to extend your runway. Now.
When a recession hits, it gets a lot harder to raise capital. You need to extend your runway or your “cash out date,” so plan to survive on the capital you have. Only spend money to make to your product or service better or to drive new sales. No more “nice to have” expenses: Scale back on new initiatives, prioritizing only those that have a near-term chance of success.
In recessions “cash is king,” so you need to make sure you have enough to get through to the eventual expansion. Take on a line of credit to augment your equity capital. Interest rates are still reasonable and cheaper than new equity funding, even with rates rising.
Proactively embrace your best customers.
A recession is a perfect opportunity for you as CEO to strengthen your relationships with your biggest and most important customers. Remember they are feeling the threat of recession as well. Customers always want to meet the CEO of the company they have purchased from so this is an opportunity for you to hit the road, visit customers, and spend time with your salespeople. If you cannot have an in-person meeting, meet on Zoom. If you are uncomfortable selling, get over it. I recently spoke to a founder/CEO with a technical background who told me he “learned to appreciate sales” even though he was uncomfortable selling at first. If you’ve historically thought your time was best spent on product, it’s time to reconsider: In a downturn, your best use of time is talking to customers and making sales.
Remember that it is easier and cheaper to sell more to existing customers than to land new customers. This is especially true in a recession as everyone is taking a second look at all expenses. If you are in a B2B business, visiting customers also gives you real insight into how happy your customers are and whether you are at risk of customer churn. If you run a B2C business, invest in rewards programs and other initiatives to make sure your best customers feel appreciated. Churn risk increases during recessions as companies prioritize their spending and pull back on new initiatives. High churn rates have a direct impact on company valuations. As a CEO you are in the unique position to lead by example and your employees will recognize your effort.
Stay close to your venture investors.
2020 and 2021 were frothy years for venture capital and many venture firms bid up start up valuations to unsustainable levels. Those same investors must now decide which of their portfolio companies to prioritize and support as the economy slows. Investors will need to reserve capital for subsequent fund-raising rounds for portfolio companies to see them through to success.
In 2022 down rounds are becoming more common. As a CEO, admitting that your company has a lower valuation can be very difficult. It’s important for you to communicate often with your venture investors to make sure they see your long-term potential.
Embrace your best employees.
Recessions force employees to re-think their career choices. If employees start to doubt the viability of the company, they will take the calls from larger firms in the market — regardless of their equity upside — that can pay more in current income, bonuses, and benefits. Get ahead of this. Spend time with your best employees making sure you understand their mindset. Employees always assume their equity stake is based on the last round of funding, so down rounds create employee angst. Losing top talent will have a very negative impact on your company. Managing and maintaining your momentum is critical both in terms of retaining your top talent as well as recruiting new talent.
Several times in my career I got ahead of this issue by offering additional stock option grants to top employees to make sure they did not even take the recruitment calls. It works. It’s far easier to get ahead of retaining top talent than it is to try to counter-offer once your employees are entertaining other options.
Emphasize and rally around your unique culture.
In my experience as a CEO, culture was by far the most important determinant of employee retention. Employees know their market value, and most stay with you if they are compensated and happy and feel they are making a difference. Focus on culture and communicate your company’s uniqueness and value proposition.
At Black Duck Software, an enterprise security startup, we created an equity and learning culture. Every employee was a shareholder and viewed the company as their own. We created learning and education opportunities and employees felt they continued to learn and grow by being part of the company.
Unique and identifiable culture is critical to motivate your entire team ready to fight through adversity. It may seem counterintuitive to both reduce expenses and focus on culture. It’s possible because funding unique cultural events is not expensive. It really is the thought behind the gatherings that count and that have an impact on employee morale. At Black Duck we held a Star Wars lego building competition for our software developers. The event was widely popular as the developers were able to publicly display their creativity and have fun, and it did not cost much to pull off.
Every company’s culture is different, but now is the time to double down on it. A good culture will help retain talent and ensure that you’re able to make it through tough times.
Recessions are a natural part of the business cycles and companies of all sizes must weather them or wither. Startups face a unique challenge because until they become profitable, they rely on outside capital to fund their growth and evolution to maturity. To make it through and emerge even stronger, conserve cash, and pay close attention to your customers, investors, employees, and culture.
Lou Shipley is the former CEO of Black Duck Software and is a lecturer in technology sales at Harvard Business School. Lou serves on five early stage technology boards and has been an executive in residence at General Catalyst.