Column: Startup Funding — Where We Are and Where We’re Going

Building a startup means going through cycle after cycle of uncertainty. One minute you’re on top of the world, raising venture capital and growing. And the next, you’re facing hard times.

I have experienced these cycles five times during my career. When I co-founded Hotwire, I went from the tech burst bubble of 2000 to the post 9/11 travel recession of 2001. I faced the Great Financial Crisis in 2008 when I was with Zillow. Most recently, with my company Pacaso, we’ve had to cope with the pandemic. Then there was a venture capital chill this year caused by inflation, rising mortgage rates and a general “risk-off” mentality in the market.

While these downturns were all difficult, I wouldn’t trade them. I learned from them. Comparing the financial crisis to the concerns we’re facing now, we can see similar threats. Inflation has run rampant throughout the country, and businesses are laying off workers and trying to cut costs as a recession looms.

There are also differences in how these issues develop and how we respond to them. The Fed has been aggressively raising interest rates, including by 0.75% just this week, and will continue to do so. They hope to stop a repeat of the early 2000s, and some predict it won’t be as bad as the recession in the 90s. The IPO window will remain closed until at least Q1 2023, and probably not reopen until Q2 2023.

How To Deal

As I said before, I’ve been through this time and time again. Along the way, I’ve found ways to lessen the blow. Here’s what I know now that I wish I knew then:

• Cut To Survive. Cut back on any non mission-critical expenses to ensure that you and your business survive. It’s notable that in this 2022 down cycle, startups have adjusted to belt-tightening very quickly thanks to Twitter and other social media amplifying advice from their peers and their investors; in past down cycles it took several quarters for most companies to adjust.
• Prioritize. Ruthlessly prioritize and adapt to the current reality. Don’t be afraid to cut projects. For example, Hotwire pivoted the business towards hotels in 2001 when travelers decided to stop flying, and Pacaso is focusing on certain markets and customer types in response to macroeconomic challenges.
• Don’t Be A Hero. When times are tough, don’t play the hero by being overly ambitious. You won’t get any credit for 20 extra points of revenue growth in 2022 anyway, so it’s okay to do 0-20% revenue growth. Again, cut to survive.
• Manage Your Board. Increase your communication with your board members so they understand what is happening in the company. Directors don’t like surprises. Founders are going to need their Board to be in their corner for advice, mentorship and potentially financial support from inside investors. So over-communicate early and often.
• Reconnect Employees To The Mission. If your employees are struggling or disheartened, reconnect them with the company's mission. Remind them why they joined the company in the first place, and that they can do some of their most important career-defining work during down cycles.
• Silver Linings. First, competition is lessened during down cycles because it is hard for startups to get funded. This benefits the more durable, better funded companies, as I saw at Expedia from 2001-2003 and at Zillow from 2008-2011. Second, customer behavior tends to change during recessions which enables new innovative businesses to emerge. For example, during the real estate recession of 2008-2011, real estate agents increased the proportion of their ad spend from newspapers to the internet which benefited Zillow greatly despite the housing recession.
• Always Be Raising. This one you’ve heard me say many times before. Raise now if you can, and raise as much as possible.

So, what happens next?

Assuming that nothing dramatic happens geopolitically, the venture investing dam will probably break in early 2023. In other words, it is going to be very difficult for startups to raise venture capital for the rest of 2022, and in early 2023 the funding market will improve. But that just means more checks will be written and more funding rounds will be done; it does not mean that valuations of these rounds will improve. On the contrary, venture rounds for the next six months are going to be at much lower valuations than founders have been used to, and they will include much more structure (i.e., downside protection for the investors) than in the past.

Also, the types of companies that get funded will change as compared with 2020-2022. Venture investors are now focusing on unit economics and profitability rather than growth. This will also be true in the IPO market where the first companies that go public when the IPO window reopens (likely in Q1 2023) will be well-known brands, must-own IPOs, with profitable durable businesses. The speculative earlier stage unprofitable companies that went public during the boom times of the last few years will not be able to go public until 2024 or beyond.

So, buckle up for the next few months and prep your company for the new world of venture investing in 2023. Just like all cycles, this one will end, but the conditions on the other side will require adjustment.