Like all industries, the technology sector is cyclical. 1 The availability of capital during up periods allows companies to grow rapidly (in some cases with poor unit economics when growth is chased as a primary focus). During the down periods companies need to fundamentally change their behavior in a cash scarce environment (growth is often, but not always, sacrificed for profitability).
I have lived through the downturns in two cycles: the end of the bubble in 2001-2002 and then the financial crisis in 2008 (which ultimately impacted tech in only a minor way and was not anything like 2001). Given that these cycles occur in 5- to 15-year increments, a new flock of entrepreneurs is ascendant at any given tech cycle and people tend to make the same mistakes with each cycle when times turn sour.
If you are an early stage company (e.g., 5 people with $2M in the bank) the primary thing you should do is seek product/market fit. Beyond not spending irresponsibly, there is not much else you should change in how you operate in a downturn. Some of the greatest companies in tech were founded or funded during downturns (HP and Cisco being two of them). 2 Google and Amazon really hit their stride as the entire technology industry collapsed around them post-2001.
If you are a mid- to later-stage company (e.g., 40 people to hundreds of people) you should think through the company’s finances and plan ahead.
During a technology cycle downturn you should do the following:
1. Focus on cash. Running out of money is typically how a later-stage company goes out of business. Check your cash position—how long will it last based on projections? During downturns you may want to pad things up to three years in case capital freezes up for a year or two. Ways to increase runway include:
- Raise money. Aim to have three years or more of cash in the bank. If you have to, raise a round at a low valuation and don’t over optimize.
- Watch expenses. Don’t spend money unless it is really necessary. If you need to scale up sales, definitely do so. Keep doing whatever is needed to make your company successful—but be cheap about how you approach it. Think hard about pound-foolish/pennywise trade-offs. For example, don’t cut snacks in the office and then spend lavishly on first class flights for the sales team.
- Increase profitability. How can you make existing sales higher-margin or revenue-accretive? If your current sales are unit margin negative, how do you fix that? Quit focusing on growth if you are losing money with every sale—this just means you are accelerating your burn. 3
- Fire bad customers or markets. A number of your customers may be unprofitable to serve. Remove them as customers to decrease burn.
- Hiring plan. Figure out your hiring needs for the next 6–12 months. What does the company really, truly need? If you cannot raise money or increase profitable sales you may need to decrease the size of your team. If you continue to hire, soon truly great talent will start looking around for a new job. You may be able to reset your hiring bar even higher.
- Real estate: the silent killer. While you can decrease staff or other expenses, real estate is tough to unwind in a downturn. In boom times you can sublet space at a profit, but when things go bad suddenly there are a ton of people locked in to high-priced real estate. This means you cannot sublet your space, because everyone else is trying to do the same thing and the whole market is upended. If the company you are subletting to goes under, you may suddenly lose an important cash stream. Don’t sign any big multi-million dollar real estate deals or build out a huge new space unless you have ongoing access to capital or are profitable.
2. Be open with your team. Even if you are in great shape, your team may still worry that your company may end up in trouble.
- Ignore the noise, and tell your team to do the same. There will be a lot of noise in press and blogs about how the whole world is falling apart. This is a normal press cycle—just as it was impossible to fail six months earlier and everyone had a $10 billion valuation, in a downturn even great successes will be questioned as failures for a 6–12 month period.
- Explain your financials. You can also work your team through financials, cash flows, and sales plan as another way to show them that everything is okay and your company is a stable oasis amidst all the noise.
3. Think about how to take advantage of it. Downturns can present opportunities for startups. Your competitors may run out of cash and not be able to replenish reserves: Should you start a price war with them? You can hire amazing people if others are cutting headcount: Who should you go after or revisit as a recruit? You can learn to impose greater financial discipline and recapture your frugal startup roots (if you have been spending too much).
At a high level, watch your cash, be open with your team, and don’t panic.
- Business cycles: See Wikipedia for an introduction. Link on eladgil.com. [https://en.wikipedia.org/wiki/Business_cycle]
- See Aaron Harris, “Don’t Focus on the NASDAQ.” Link on eladgil.com. [http://www.aaronkharris.com/dont-focus-on-the-nasdaq]
- Two counter examples to this would include: a. You are a consumer, network effect driven business and will largely be valued on user growth rather than monetization in your current stage of company (note, this does not last forever, but should last for the first few years of a consumer company). b. You have a huge pile of cash, and you can destroy your competitors by causing them to spend even more money and go out of business.