RIP Good Times 2.0 - A summary of recent macroeconomic events and what tech startups can do to weather the storm

How did we get here? - A summary

Global markets have been on a bull run since the last financial crisis in 2008 (MSCI World Index rising roughly 6x till its peak in 2021). We were awash with optimism, dry powder and liquidity. Everything that was investible was red hot, including cryptocurrency, NFTs and even emergence of meme stocks. Then China started to clamp down on its tech sector, detrimentally affecting it. China-US relationship also deteriorated due to the trade war. This did not bode well too as there are circa 260 Chinese companies listed on US exchanges, with total market capitalization beyond USD1Trillion. Oh and then there was COVID. This unprecedented and unexpected event threw the world into chaos. Governments scrambled to fund the fight against the virus, manage their local economies, and to sustain their population's livelihood. Supply chains stood still and borders were closed. Due to the extreme pump priming by governments, many had excess capital and investment into speculative (Ape NFTs anyone?) and riskier assets were flush, such as cryptocurrency, seed funds, tech stocks, SPACS just to name a few. FOMO sentiments were high (and maybe even some YOLO). Interest rates were low which bode well for consumer spending, BNPLs etc.

When there was light at the end of the tunnel and the pandemic turning endemic, Russia attacked Ukraine. Without going into specifics, this caused widespread pandemonium. Crude oil price skyrocketed (Russia is a large producer), as well as commodities such as wheat and fertilizers, which had a huge impact on the agricultural (and food) sector. Supply from that part of the world stood still. On top of that, sanctions by the US and its allies further intensified this shortage. Additionally, other factors that caused the extreme rise in oil price was the demand for oil was low during the pandemic (leading to reduced output), and coupled with the fact that upstream oil companies were reducing their capex investments to focus on a shift to renewable energy. This created a huge inflationary pressure, as fuel, oil and food are the most crucial necessities (oil price directly impacts transportation), leading to many central banks having to aggressively tighten their fiscal policies to rein this in, in order to control prices. Thus, interest rates had to be raised, which might also tip economies into a recession if they rose too fast, hence balance has to be struck. China took a strong stance in zero tolerance for COVID cases and remained closed and locked down for much longer, further impacting many supply chains (this is huge as trade with China is 15% of global) and adding to inflation.

Another event worth mentioning was the disconnect between Terra and Luna. These cryptocurrencies were supposed to be algorithmically pegged to USD (hmmm..) but collapsed drastically, taking down even crypto hedge funds and lending platforms. This is a story for another day, but in such jittery economic conditions, with funds already flowing towards safer havens, it caused a huge shrinkage in values of all cryptos (BTC lost around 50%), further shattering confidence in riskier assets (and tech in tandem).

How is the tech sector impacted?

1. From growth to value - When a loose fiscal policy is tightened, naturally funds will flow to lower risk assets with stronger fundamentals, such as value stocks, bonds, properties, gold etc. Tech has always been considered growth stocks, due to its high valuation and corresponding risk (higher beta). The VC space will also be affected, as they will be more inclined to invest in startups that have stronger unit economics, fundamentals or shorter breakeven horizons.
2. Dip in valuation - When interest rates rises, the discount factor used to calculate Discounted Cash Flow (DCF) will be increased as well, leading to a lower Net Present Value (NPV), hence lower valuation. This will affect all financial metrics such as PE, PS etc. For an unlisted tech company, comparables for their listed peers will be suppressed. Furthermore, as tech IPOs and SPACS struggle, it will be even more difficult for VCs to structure an exit.
3. Shift in consumer behaviour - In such a high inflationary environment, consumers will naturally focus on spending only on necessities, such as food and fuel. Those tech companies that are not providing value in these areas might suffer. Even for those who are, there might be margin compression.
4. Increased cost of funds - With a higher interest rate environment, those in the lending space (B2B, BNPL etc) might see some reduction in margins. Simultaneously, those who borrow will need to return a higher yield.
5. Shift in corporate spending - Many corporates will also be tightening their belts, with layoffs and budgetary cuts to weather the storm. This might affect unnecessary tech spending and even areas such as digital advertising.
6. Reopening of economies - During COVID we saw heavy investment interest in companies that thrived in a stay at home environment - the Zooms, Pelotons, Teladocs of the world. With a gradual reopening, Companies that function in the physical space such as retail, travel, dining, etc will make a comeback.

So what can we do?

Survive you must.

At risk of revealing my age... In 2008, during the subprime crisis, Sequoia Capital published a document called RIP Good Times to explain the situation then and provide some advice to startups. It is time to dust off this document again and revisit. Although the contributing factors to the crises then and now are different, many of the survival strategies are still valid.

In May, YC Combinator released its own shorter advisory article (& video) here.

My take:

1. Conserve cash and continue fundraising. This is a no brainer but is crucial. Extend your runway as far as you can. Cut all unnecessary spending and continue fundraising efforts. Perhaps even casting wider nets, including corporates, High Net Worth Individuals, and Equity Crowd Funding. Some Private Equity firms are even looking more into earlier stage companies to diversify out of the rut and prepare for an uptick in market sentiment. Remember - survival trumps down rounds.
2. Show me the money! Look into your arsenal of products and services to explore what you can monetise like almost immediately. You might have some tech or talent or data sitting around that someone will pay for, it might or might not even be in the same industry. You never know what you might have until you search. Get creative! Take a page from Grab that started offering GrabMaps as a service.
3. Pivot into shorter targets or new business areas. Survival mode on and do consider laying off the moonshots and come back to earth. Focus on more realistic targets that can generate revenue in the short term. Have a thought on what are the main trends amidst this downturn, there might be opportunities. For example, can your tech help corporations reduce costs? Improve efficiency? Increase automation? Solve a problem? Can your platform help match buyers and sellers or lenders and loaners more efficiently? Is there an alternative revenue stream? Are there any other areas or industries that your product can cater for? Don't just focus on what it was created to do. You might even find an investor for this new business.
4. Partner up! If you can partner with another company to achieve your goals, then do so. Low cost and speed to market is key. Everyone is feeling the pain and if something can be achieved together with the profits and costs shared then by all means do it.
5. For those fortunate enough to raise funds at a high valuation or are generating positive cashflows, congratulations! You can be a tad more aggressive to capture market share, hire good talent and even some M&A activities with multiple objectives (increase revenue, tech ownership, economies of scale, acqui-hire etc)

What's Next?

Nobody can tell how long this downturn will be, but looks like it will take a while. Indicators to keep tabs on include most importantly the situation in Ukraine, inflation rates and the Fed's stance on interest rates, commodity prices, jobs data, technological indices, corporate earnings, etc. However, as in all downturns, there is always a bottom. Survive first, prepare for the next up cycle, then thrive.

"May the Force be with you"