Emerald Technology Jul 14, 2022 2:54:26 PM 11 min read

How Tech Start-Ups Can Weather The Coming Economic Storm

As you’ve probably seen on the news, talk of recession is front and center once again. Even the optimist David Sacks, is saying that Silicon Valley hasn’t been this negative since the dot-com bust.  

The question on the tips of most tongues is, “Are we heading for a recession?”

Short answer, we’re probably already in one.   

Although the consensus is that a recession is defined by two consecutive quarters of GDP retraction, the current situation is far more complex to map alongside that fairly rigid definition. According to the chief economist at Nomura, within the next 12-months, central banks will tighten monetary policy to combat out-of-control inflation.   

Right now, central banks, many of them have shifted to essentially a single mandate — and that’s to get inflation down. Monetary policy credibility is too precious an asset to lose. So, they’re going to be very aggressive. That means front loading rate hikes. We have been pointing out for several months about the risks of a recession and we’ve bitten the bullet. And now we have many of the developed economies actually falling into recession.” - Rob Subbaraman – Nomura/Head Of Global Markets Research - Asia ex-Japan  

The United States of America, the United Kingdom, South Korea, Japan, Australia, Canada and most of Europe have already, or will fall into recession between now and Spring 2023.  

 

NO ORDINARY RECESSION

The biggest worry is with multiple economies all suffering recession simultaneously, cross-border trade and exports are no longer the safe-haven they used to be. During COVID, central banks and governments were ridiculously loose with monetary policy. 

They hoped inflation would be transitory; they were wrong, and now it’s a giant game of catch up as inflation spirals and banks attempt to stem the flow of blood.   

Indicators suggest this coming recession is low-n-slow. Around 5 quarters long, beginning in the Autumn of 2022. Which takes us all the way to 2024 before we see any hope of light at the end of this financial tunnel.   

The European Central Bank and the Federal Reserve are already nudging interest rates up to ease the pain, but it isn’t working. For instance, the Federal Reserve increased interest to 1.75% in June, with predictions that July will bring another hike in interest rates.  

Nomura predicts that by February 2023, The Fed will run at a 3.75% rate. The biggest worry is mid-sized economies like Canada and Australia that hold massive amounts of housing debt because of housing booms in recent years. If interest rates hit a certain threshold, we might see a repeat of the housing crisis of 2008/09.  

Unfortunately, high interest rates are the only way banks can hope to stem the problem. Of course, the other solution is to let inflation run rampant, and get stuck there for years like we experienced in the 1970s.   

So, what does this mean for the tech world?  

  

WHAT ABOUT THE TECH INDUSTRY?

Historically, during an economic downturn, businesses can get greater market share by simply surviving. The question becomes, how do we push forward in an economy rolling backward? 

In 2008, Intel’s CEO Paul Otellini was asked what his plans were. He immediately answered, “Double down on R&D, look for and nurture young talent and accelerate expansion plans.” Obviously, he was 100% correct.  

But that’s easy to say when you have the cash reserves of Intel, it’s not the same for start-ups. 

Especially when phrases like “Prepare for the worst.” and “It doesn’t look good.” are being thrown around at industry stalwarts like Y Combinator. This is in stark contrast to last month when the same Y Combinator were showcasing start-ups on Demo Day. Many of which had already secured some funding. The economic speed bump is also going to affect international companies disproportionately (probably because of exposure in weaker markets).  

 

HOW MUCH CASH ARE YOU BURNING?

TechCrunch got a series of memos from venture capitalist firms to portfolio companies concerning the downturn. The vibe was pretty much universal. “Can you tell us your ARR and cash burn in writing?”  

Our guess is that companies who couldn’t say yes were in for a rough ride.   

Workrise, On Deck, Netflix, Hopin, Robinhood, Peleton, Go Puff... the list of companies with massive rounds of layoffs keeps getting longer. Most of which is just an inability to keep up with pandemic-era demand. Swelling the books to 400+ staff during lockdowns, then realizing 120 will suffice during a recession. None of this matters though, investors want a return, and no amount of placating will fix the glaring issue, these companies aren’t making any money.   

An inability to raise Series B/C funds leaves these companies with no financial runway. Or at least a dramatically shortened one. Projects like Tudum (a Netflix owned editorial arm with interviews, trailers and movie news), shut down only 6-months into the project. Bad news for the dozens of BuzzFeed and Vice journalists, lured away by bigger pay days, only to find themselves on the street a few months later.   

Not that staying at BuzzFeed would have helped. Shortly after acquisition, they fired 47 HuffPost workers via Zoom with the password “spr!ngisH3r3” for added insult.   

Funding is drying up internationally too, not just on American shores. So, what does this mean for us and what can we do about it?  

Here are a few predictions for the next 18-months and some measures you can take to navigate these shark infested waters.   

 

PREDICTIONS:

 

  • Weak balance sheets are going to be a giant red flag. Any business with a flimsy-looking balance sheet will run out of cash fast and find it near impossible to raise more. If you think “How do they stay in business?” they probably won’t. Big names will vanish overnight and get carved up by the sharks.   
  • Restructuring will get creative; buyouts and mergers will come thick and fast, assuming the money is available.   
  • C-suite executives will get culled first. It happens every time an economic downturn affects a business. It’s easier to quantify what an exec is or isn’t doing, so off to the chopping block they go if the numbers don’t match up. On the flip side, execs with strong track records will jump ship way before this even happens. Expect to see seismic amounts of C-suite chess among top tech 500 and even much smaller companies.     
  • Large companies will cut any loss making projects loose (like Netflix killed Tudum recently) and focus on core services. Smaller companies will come in and gobble up the niche markets and disrupt the space.  
  • Economic growth and advertising spend walk along the same path. Businesses who rely on ad spend will be in an all out war to gain eyeballs and thus ad revenue. Smaller companies like Twitter and Snapchat might fold under the crippling weight of debt and miniscule ad revenue being garnered.   
  • Expect shareholders to go after boardrooms to claw back lost money. Boardroom activism and lawsuits will fill the news cycle as shareholders seek to blame the boardroom (since the government isn’t listening).  
  • Speaking of activism, employee activism like Spotify employees threatening to walk out over Joe Rogan’s content, or Netflix employees threatening to leave over Dave Chappelle’s special... will vanish. With layoffs leaving the workforce scared of unemployment, and businesses focused on profit over social street credibility, expect to see employees doing more work and less activism. This may or may not lead to company diversity quotas going by the wayside too as businesses focus on profit alone. 
  • Inequality (rich vs poor) will be magnified. Now is not the time to brag about your new offices or your bottomless buffet at the Christmas party. Play humble or expect the wrath of social media to destroy whatever brand credibility you had left.   

 

SOLUTIONS:

  

  • Switch to an Employer of Record for your hiring needs. It’s far more secure than hiring people as freelancers and not as risky (employee misclassification.)
  • Switch to external teams and outsourcing so you get more bang for your buck. Using an external marketing agency instead of building your own is a no-brainer in 2022/23.  
  • Cut any loss-making subsidiaries and focus on cash-flow positive parts of your business. Better to have one solid core offer that makes money, than five offers barely paying for themselves.   
  • Make the most of your cloud. By 2025 over 50% of IT spending will be cloud services, a lot of it wasted on unused capacity and resources.  

 

An entire generation of entrepreneurs has built confidence off the back of an amazing 13-year bull market. This transition is going to be hard, painful and even disturbing for some. But as with any cloud there’s a silver lining, this recession won’t last forever. And just like Intel did in 2008, you can position yourself for an amazing boom cycle once it’s over. 

You just need to have the right team in place. 

 

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