Framework: Advice for Founders Navigating Market Corrections and Sudden Economic Instability

"It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change." — Charles Darwin

In Spring of 2022, as the economy and markets were beginning to deteriorate dramatically, a number of venture firms came out to advise their companies on what was changing and what they should all do to prepare their businesses for the tougher times to come.

Sequoia advised their founders that this was a Crucible Moment in which every company would be tested — but where the very best could also come out stronger. YC advised their companies to "plan for the worst."

While the context here was timely and unique, the advice was timeless. It acts as a guide for what founders and companies should do when economic conditions and market realities deteriorate quickly. When a tectonic shift happens in markets that change everything — seemingly all at once.

As you'll learn, the key to is to not fool yourself and recognize the new reality and adapt to it aggressively so you can move from defense to offense as quickly as possible. Difficult markets enable the best companies to go on offense and come out stronger.

Here's timeless advice for founders and companies navigating a quickly deteriorating market and challenging macroeconomic conditions:

• Recognize the new reality and adapt to it quickly.
• Quickly cut and consolidate to a position of maximum strength.
• When times get grim you’ve got to become the Grim Reaper.
• Expect to face headwinds and challenges from all directions.‍
• Understand that the cost of capital has gone way up.
• Manage your resources wisely to ensure your survival.

Recognize the new reality and adapt to it quickly.‍

The speed at which you can recognize the new reality, reassess your approach, and make the necessary moves the better. Ultimately, your goal is move from being forced to play defense to being able to play offense again as quickly as possible. 

• Don't panic. Intentionally pause and reassess.
• The first step is always the hardest. Every crash starts with founders not confronting reality.
• Rapidly changing markets require that you adapt your strategy and approach quickly. Those who adapt the fastest are the best positioned to succeed. While those who adapt the slowest, tend to simply compound the pain they'll face when they eventually are forced to adapt.
• Adapting to a new reality is always hardest for those who excelled the most in the previous reality. They've been rewarded for a certain way of operating that's unlikely to work to the same degree — or any degree — in the new reality.
• Respond with intention now, rather than regret later.
• Understand that uncertainty will be ever present. Backward-looking fundamentals can't clarify what's to come. Focus on the most likely path of travel and build in a margin of safety into everything that you do.
• Once you confront reality, you have to prevent yourself from spinning into a negative cycle. Remember that courage is a choice — so choose courage and vow to prevail. Confront your fears and then consciously choose courage over fear at every step.
• How are you going to ensure you see reality, face it head on, and adapt quickly?

Quickly cut and consolidate to a position of maximum strength.

When faced with new risks and uncertainties, your first priority should be cutting everything non-essential and consolidating to a position of maximal strength. Doing this quickly will give you the best chance of competing and winning in an adverse market.

• Trade short-term pain for long-term gain.
• Cut non-strategic costs to the bone. That’s everything that does not move the needle on your most important metrics and priorities — which should all reinforce the durability and profitability of your business.
• Cut more than you think you need to upfront or face a cascading series of cuts that erodes morale.
• Get rigorous around strategic costs: things that contribute to retaining customers and growing profitably. But remember to continue investing where returns are the highest. Competitive forces are weakest in adverse markets, which makes winning easier for the strongest players.
• Remember that the pain of discipline is always less than the pain of regret. Make the tough decisions upfront, be aggressive, secure your firm's survival. Cutting the right way will make your business stronger and more durable — not weaker.

When times get grim you’ve got to become the Grim Reaper.

Treat adversity as your call to greatness. When times get tough, those that can raise the level of their gameplay amidst all of the challenges will come out stronger. Commit to do just that from day one.

• Re-strengthen your focus. Make sure every hour and dollar is being invested behind your most important priorities.
• Put more wood behind fewer arrows.
• Top grade everything. As you’re cutting and pairing down, improve end quality and output across every dimension. Give your best people more authority, poach the best talent on the market, raise your standards for everything.
• Transform from the Navy into the Navy SEALs. Start by reminding yourself of the why, reaffirm your mission and values, and ask for team's commitment to the highest standards.
• Think of everything that’s come before as your offseason. Now it’s game-time. Everyone must operate at a faster tempo, to higher standards, with more rigor. No exceptions.
• Remember that the one who wins is the one best prepared for the fight. First prepare your own mind, then your team, and then your company to win in this new market.

Expect to face headwinds and challenges from all directions.‍

In adverse markets, expect to face pressure and novel challenges from all sides — employees, customers, and suppliers. Challenge markets eventually effect every layer, although typically somewhat differently, that compounded can feel like a giant superset of challenges.

• Against softening macroeconomic conditions, every stakeholder begins to vie for what's best for them and the broad order is often reset.
• As employees face rising costs, often from inflation, they'll demand higher pay.
• As suppliers face declining revenue and rising costs, they'll ask for higher prices.
• Lenders may begin to enforce covenants, restrict lending, or ask to renegotiate loans altogether as they go into risk-aversion mode.
• Interest rates may rise, even dramatically, making credit more expensive.
• All against a backdrop of declining revenue, slowing sales and growth, and a focus on cutting costs — creating an enormous challenging set of conditions.

Understand that the cost of capital has gone way up.

One of the the most prevalent knock-on effects is that the flow of capital slows while the cost of capital risks simultaneously. As capital becomes harder to raise overnight, the value of every dollar goes way up — which is why cutting expenses and doing more with less is non-negotiable.

• In difficult markets, fear plays a larger role and shapes how people perceive both opportunity and risk. Which is why the cost of capital rises dramatically.
• As people search for sure bets and avoid unsure ones, valuation multiples come down to historical norms (typically 3-5x), capital becomes harder to raise and costs more (e.g. higher dilution and less friendly terms), and liquidity dries up slowing the supply of money.
• Inevitably that means every company has to fight harder for every dollar of revenue and investable capital.
• Every dollar in costs cut by one company is a lost dollar in revenue for another company — which creates a vicious negative flywheel of revenue loss and cost cutting. Often this plays out in waves, as company cut headcount and costs in a race to stay as competitive as possible.
• Given every dollar is more precious than it was, how are you going to change your priorities?

Manage your resources wisely to ensure your survival.

Part of recognizing that every dollar has become much more valuable is ensuring that you're managing every aspect of your finances as rigorously as possible. That starts with paying incredibly close attention to your cash flow, margins, operating expenses, burn rate, net cash position, and especially your runway.

• Start with your cash. Ensure you know your cash position, cash flow, and cash runway — ideally daily, at the very least weekly. Without this understanding you have to recognize that you're flying blind.
• Control your expenses. While profitability is always an output, recognize that you control the key inputs by setting prices and controlling operating expenses. Don't be afraid to force your entire company to work within much tighter constraints. Ask your team to respond creatively.
• Solve problems with muscle not cash. In lean times, you're forced to solve problems with creativity and hard work. You can no longer simply spend away your problems. Treat this as an opportunity to get leaner and stronger — like any workout, expect this to require hard work and ask your team to step up to the challenge.
• Manage your runway. First compute your runway by computing your net cash position (cash - any drawn venture debt) and dividing that by your monthly burn (total reduction to your net cash position). Ultimately, decide on a monthly burn rate and focus on keeping that constant so you can manage your runway in real-time.

Go deeper.

YCombinator's Advice

Greetings YC Founders,

During this week we’ve done office hours with a large number of YC companies.  They reached out to ask whether they should change their plans around spending, runway, hiring, and funding rounds based on the current state of public markets. What we’ve told them is that economic downturns often become huge opportunities for the founders who quickly change their mindset, plan ahead, and make sure their company survives.

Here are some thoughts to consider when making your plans:No one can predict how bad the economy will get, but things don’t look good.The safe move is to plan for the worst.  If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days.  Your goal should be to get to Default Alive.If you don’t have the runway to reach default alive and your existing investors or new investors are willing to give you more money right now (even on the same terms as your last round) you should strongly consider taking it.Regardless of your ability to fundraise, it’s your responsibility to ensure your company will survive if you cannot raise money for the next 24 months.Understand that the poor public market performance of tech companies significantly impacts VC investing.  VCs will have a much harder time raising money and their LPs will expect more investment discipline.
As a result, during economic downturns even the top tier VC funds with a lot of money slow down their deployment of capital (lesser funds often stop investing or die).  This causes less competition between funds for deals which results in lower valuations, lower round sizes, and many fewer deals completed.  In these situations, investors also reserve more capital to backstop their best performing companies, which further reduces the number of new financings. This slow down will have a disproportionate impact on international companies, asset heavy companies, low margin companies, hardtech, and other companies with high burn and long time to revenue.
Note that the numbers of meetings investors take don’t decrease in proportion to the reduction in total investment.  It’s easy to be fooled into thinking a fund is actively investing when it is not.For those of you who have started your company within the last 5 years, question what you believe to be the normal fundraising environment.  Your fundraising experience was most likely not normal and future fundraises will be much more difficult.If you are post Series A and pre-product market fit, don’t expect another round to happen at all until you have obviously hit product market fit. If you are pre-series A, the Series A Milestones we publish here might even turn out to be a bit too low.If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn.  Remember that your chances of success are extremely low even if your company is doing well.  We recommend you change your plan.Remember that many of your competitors will not plan well, maintain high burn, and only figure out they are screwed when they try to raise their next round.  You can often pick up significant market share in an economic downturn by just staying alive.  For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn.
Best,

YC

PS: If for whatever reason you don’t think this message applies to your company or you are going to need someone to tell you this in person to believe it… please reassess your beliefs on a monthly basis to make sure you don’t drive your company off a cliff. Also, remember you can always reach out to your group partners.

Sequoia's Advice

We believe the current market environment is a Crucible Moment that will provide challenges but also opportunities for all of you. Many legendary companies are forged during challenging environments as competition thins, real businesses get built and the opportunity for innovation is seized by those who see it. 

We shared this presentation with Sequoia founders in May, and are now sharing it publicly with the wider startup community. Whether you are a CEO, operator or an aspiring founder pondering what it will take to build a successful company in a rapidly changing business climate, we hope this will prove a useful toolkit. No matter your role, the key to thriving in the next period is confronting reality, and acting decisively to adapt.