Survival in Times of Economic Downturn: YC and Sequoia give Founders the Heads Up

Among a chorus of venture capital firms and investors, acclaimed startup accelerator, Y Combinator, and prestigious investment firm, Sequoia Capital, have expressed their concern about the risks to start-ups amidst the current state of the macroeconomic market.

The famed investment company, Y Combinator - which had early backings in Dropbox, Airbnb, and Coinbase - has advised their portfolio of young startups to “plan for the worst” and aim for “default alive” as the market teardown will prove tricky to handle after a 13-year bull run. 

“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.”

The letter from YC titled, “Economic Downturn” suggests its startups reduce their expenditure, concentrate on extending their runaways as soon as possible, consider extension rounds and reflect on more disciplined spending. “If your plan is to raise money in the next 6-12 months”, the letter reads, “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.”

But YC hasn’t been the only one to get the word out; set out in a 52-page presentation, Sequoia Capital - an acclaimed venture capitalist company - identified a plethora of risks and challenges founders will incur when raising capital and operating as usual in the thick of the current economic shift. 

Sequoia Capital has been known to sound the alarm before times of crisis; before the 2008 economic meltdown, Sequoia published the infamous “R.I.P. Good Times” memo and the “Black Swan” memo followed in the wake of the COVID-19 pandemic. 

In their latest memo, Sequoia partners, including Alfred Lin, Roelof Bota, and Doug Leone, state that they “expect the market downturn to impact consumer behavior, labor markets, supply chains and more. It will be a long recovery and while we can’t predict how long, we can advise you on ways to prepare and get through to the other side” the presentation states.

Sequoia partners have advised their portfolio of founders to cut costs across marketing, R&D, projects, and other expenses and to forget growth “at all costs”

“First and foremost, we must recognize the changing environment and shift our mindset to respond with intention rather than regret,” the presentation reads. Having made early investments in Apple and Airbnb, Sequoia has earned a name as one of the most reputable venture firms in Silicon Valley. In a bid to avoid a “death spiral”, Sequoia partners have advised their portfolio of founders to cut costs across marketing, R&D, projects, and other expenses and to forget growth “at all costs”. “Companies who move the quickest have the most runway and are most likely to avoid the death spiral,” the presentation says. “Look at this as a time of incredible opportunity. You play your cards right and you will come out as a strong entity.”

“We do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery like we saw at the outset of the pandemic.”

Pointing to geopolitical conflicts, the war in Ukraine, supply chain issues, the Federal Reserve’s move to increase interest rates and sustained inflation, Sequoia Partners say “quick-fix” policy solutions, such as cutting interest rates or quantitative easing, will be substantially limited this time. In the wake of the covid crisis, monetary and fiscal policy responses created a distortion field in the markets. However, “This time, many of those tools have been exhausted,” the presentation said. “We do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery like we saw at the outset of the pandemic.” The presentation also highlights that investors’ focus is moving towards companies that can “generate cash today” and with profitability.

During the pandemic, many tech companies experienced rapid growth, however, such businesses are cutting jobs and halting hiring; even Netflix and Klarna have set out their plans to reduce their global workforce by 10%. Facebook owners, Meta, are among top companies, such as Uber, who are slowing hiring too. Furthermore, high-growth stocks have lost two years of price appreciation and 61% of all software, internet and fintech companies are trading below pre-pandemic levels.

“The era of being rewarded for hypergrowth at any costs is quickly coming to an end,” the Sequoia presentation reads. “It might not translate into your valuation overnight, but over the medium and long term, disciplined, durable growth is always rewarded and translates into meaningful value appreciation.”

The Sequoia partners also forewarn that unlike in previous times of crisis, “cheap capital” will not be saving the economy anytime soon. Yet, despite the bleak overall forecast, Sequoia praised former resilient partners and pointed to the opportunity for tough founders to thrive. The presentation highlights the success of Google and PayPal making it through the dot-com bust and Airbnb for surviving the financial crash. “The message we wanted to get to founders was that for the best companies, this should be your time to shine because when it’s easy for everyone to fund-raise and get demand you don’t see as much of the strength of some of the distinctive businesses and teams,” said Sequoia Capital’s growth team expert, Michelle Bailhe, to CNBC’s Crypto World. “The playing field has gotten tougher, which would benefit the types of people that make most of this opportunity.”