A recent Wall Street Journal headline summed it up: “If the U.S. is in a recession, it’s a very strange one.”
Economic output is falling, yet the job market remains strong. The pandemic economy has been anything but normal, and world factors, including inflation, supply chain struggles and global conflict, all contribute to growing uncertainty about when and for how long things will get worse economically. In venture capital, the alarm has already been sounded, with investors asking companies to cut staff, reduce expenses and focus on the bottom line.
With uncertainty generating rampant speculation, keep in mind that one crisis does not fit all. Whether you are an investor or an entrepreneur, moving forward starts with taking a step back.
- Recent venture capital trends have set the stage for a major correction. Last year, $330 billion poured into U.S. tech companies, driving funding round sizes and valuations to record levels. Large capital infusions, particularly in later-stage tech companies, pushed growth strategies to full throttle. Any pullback will feel more severe because the market was unsustainably hot. In short, if it is time for an economic reality check, the fall may feel farther, as we are stepping off a peak, not a plateau.
- Investor perception is reality. Irrespective of how economic trends play out over the months or years ahead, the widespread belief today that VC funding is tightening in anticipation of a recession is creating a self-fulfilling prophecy. Valuations are yielding to downward pressure. Investors are becoming more selective, and conservative cash flow management is a growing focus. This isn’t a wait-and-see situation; it’s already here.
- Reactive, across-the-board solutions can backfire. While it may make sense for some startups to pull back on costs to extend their runway, it doesn’t make sense for all. A company with a long cash flow runway that is managing top- and bottom-line performance probably doesn’t need to pull back, particularly in staffing. The talent market is so tight today that companies can do more long-term harm than good by reducing staff, as it might not be easy to add that talent back. Companies need to actively engage their boards and investors to align on a plan that will weather the storm. Acting on impulse is never a good idea.
- Good deals will get funded. Companies that perform by hitting value-creating milestones will still be able to raise capital on reasonable deal terms. Demonstrating solid business performance fundamentals while continuing to introduce customer-driven product enhancements will drive value and attract capital. While there may be pullback in the VC market, a record amount of capital is still out there and needs to be invested.
From an investor perspective, economic downturns can create opportunities. Investors can be selective with valuations trending down to earth and the pace of investing leveling off. History shows that venture funds that have invested during economic downturns have produced exceptional returns.
Opportunities that address big problems in large markets, demonstrate strong product/market fit and have capital-efficient funding runways will stand out. With all the disruption generated by digital transformation and plenty of venture capital yet to be invested, the market remains primed for innovative early stage companies to emerge and succeed. ●
Jerry Frantz is President of JumpStart Ventures