Are we headed toward a recession, and how should startups prepare?

In 2023, economic uncertainty poses challenges for startups. This blog discusses the current climate, explores the potential for a recession, and suggests key strategies: controlling burn rate and fundraising tactics. Operational tips include phased growth and cautious hiring. Adaptability is important for startups in uncertain times.

A Climate of Uncertainty

As we navigate through 2023, the economic climate is shrouded in uncertainty. Every day, the media is awash with reports of significant layoffs in large corporations, painting a picture of an unstable job market. The collapse of SVB has sent shockwaves through the financial world, eroding investor confidence. The soaring inflation rate squeezes budgets, and alters consumer behaviors.

In this backdrop of economic turmoil, the question on everyone’s mind is: Are we slipping into a recession? We turn to the signals from key economic indicators from FRED: inverted yield curve, LEI, and housing starts. 

• Inverted yield curve

  In the bond market, longer-term bonds are offering lower yields, signaling an inverted yield curve. This suggests that investors have tempered their expectations for the long-term economic outlook.

• Housing Starts

  Housing Starts have shown a general decline since April 2022, with only a minor uptick in October 2023, signaling a potential recession and impacting sectors like real estate and construction.

• LEI

  The declining trend in the LEI and its negative six-month growth rate serve as early indicators of shifts in the business cycle. This trend suggests that the economy is likely moving toward recession in approximately seven months from now.

Understand Recession

While these key economic indicators point towards a potential recession, it's important to clarify what it entails. A recession is typically characterized by a decline in real GDP for consecutive quarters, signifying a period of economic contraction and a rise in unemployment rates.

When we examine the Fed Smoothed US Recession Probabilities curve, we can discern that a recession did occur in 2020. However, from 2022 to 2023, no significant metrics are indicating the presence of a recession. They base their determination on data related to GDP, income, employment, industrial production, and sales. 

Despite the lack of official confirmation of a recession, the pervasive sense of uncertainty is in the business world. The warning signs of a potential economic downturn remain in the market. This climate is especially challenging for startups.

How should startups prepare?

Control Cash Burn

To address funding challenges, startups can extend their runway and manage their burn rate effectively. First, reduce non-essential costs by scrutinizing expenses. Evaluate the necessary headcount, streamline general and administrative expenses, and explore more efficient marketing strategies to reduce customer acquisition costs. Second, focus on scaling up revenue. Many companies rely on advancing through fundraising rounds as their primary strategy rather than solely relying on revenue. To excel in revenue growth, it's crucial to develop effective sales strategies and channels. Meanwhile, strive to outperform in the fundraising landscape, even during an economic downturn. 

According to the data analysis by Florida International University, startup founders should aim for a runway of at least 18-21 months. The time frame is not always one-size-fits-all. It may vary by factors like your product, growth stage, strategy... The key is to have sufficient funds to sustain your operations until you generate revenue or secure funding from other sources.

Source: Florida International University

Fundraising

For startup founders, it’s imperative to place a strong emphasis on key financial metrics such as burn rate. Maintaining a robust cash flow while managing a high burn rate is crucial for sustainable growth. However, recent data from PitchBook indicated that VC funding has become extremely challenging in 2023.

Because of economic turmoil, the amount of money invested in US VC deals every quarter has dropped to its lowest point since the second quarter of 2018. In the past 18 months, the VC market has changed a lot. While the number of VC deals each quarter has stabilized, it's still not as high as in late 2020 and 2021.

Raising funds can be more challenging during economic uncertainty, as investors tend to be more cautious. Startups might have greater difficulty securing capital, especially at early pre-seed and seed stages. To stand out in this VC fundraising endeavor, here are some effective strategies: 

• Pivot business model
  In the dynamic market environment, startups can have some flexibility on the business model, responding to market feedback, trends, or unforeseen challenges. A pivot involves altering various aspects of the business model such as product and services, target customer segment, or revenue model. Pivoting is a crucial strategy for startups to remain competitive and achieve their goals in a constantly changing business landscape.

• Optimize market timing
  Startups that enter the market at an opportune time stand a higher chance of fundraising, especially when they launch during periods of increasing demand and manageable competition and have a deep understanding of evolving market trends and consumer behaviors. For instance, tech startups that emerged during the period of ChatGPT 3's rise are prime examples of capitalizing on new trends at the right time.

  
  

• Leverage team capabilities

  Investors often give high valuations to startups with teams that demonstrate strong execution skills, market knowledge, and relevant experience. A well-rounded team that can overcome challenges and achieve goals is more likely to attract venture capital.

  
  

Alternatively, startups can consider exploring other methods for attracting investment rather than solely relying on VC. Analyzing the data from YC's Winter Batch of 2023:

Acceptance and Funding Status:

52% of the batch was accepted, even with just an idea. 
28% of the batch had already raised funds before joining YC. 
77% of the batch had no revenue prior to joining YC. 

Given the notably high acceptance rate, enrolling in an accelerator program could be a promising choice for startups.

Enhance Operational Strategy

There are common tips such as cutting unnecessary expenses and hiring cautiously. We believe these tips all roll up the concept of Phased Growth and managing spending in line with your growth milestones.

• Phased growth

  Plan the growth in stages, aligning it with key milestones and objectives. Create an efficient pipeline. This approach allows for more controlled expansion and suitable budget management. For instance, a startup may initially aim to acquire 100 customers, focusing its budget on marketing and product refinement. Upon reaching this goal, the next phase could involve expanding the product line, with funds redirected towards development and market research. This step-by-step approach ensures spending aligns with growth stages, preventing overextension and resources misallocation.

• Cautious hiring

  Avoid hiring too early or too quickly. Instead, focus on roles that are essential to your business operations and growth. Utilize current employees for various activities. This approach not only saves costs but also allows for flexibility as the business grows and needs evolve.

While current indicators suggest we are not in a formal recession, the landscape is undoubtedly challenging for startups. The key to navigating these uncertain times lies in strategic planning and adaptability. How is your business navigating these uncertain times? What strategies have you found effective? We invite you to share your thoughts in the comments below.

Thank you for reading. From your friends at Truewind 💛