5 Ways Startups Can Prepare for a Recession

Startups face a unique challenge during economic downturns. They are typically not yet profitable and therefore dependent on outside funding – and are therefore especially exposed when macroeconomic conditions change. To make it through a recession, startup CEOs should hit the road and talk to customers. They should also focus on preserving company culture and retaining employees. After that, they need to do everything they can to extend their runway, including taking on a line of credit.

With stocks down 20% from their highs, we are officially in a bear market. Many economists predict we will enter a recession in the next few quarters if we are not already in one. What strategies and tactics should startup CEOs use to prepare for and survive a recession?

I have spent the past three decades in the software industry, including three stints as CEO as well as serving on the boards of 10 private companies and as an advisor to many others. I have led or advised companies through the bursting of the dotcom bubble, the 2008 financial crisis, and the Covid recession. While every downturn is different, in my experience there are some essential steps that startups should take when the economic environment deteriorates.

Take steps to extend your runway. Now.

When a recession hits, it becomes more difficult to raise capital. You need to extend your runway or “cash date”, so plan to survive on the capital you have. Only spend money to make your product or service better or to drive new sales. No more “good to have” expenses: Scale back on new initiatives, prioritizing only those that have a near-term chance of success.

In recession “cash is king,” so you need to make sure you have enough to see through the eventual expansion. Take out a line of credit to increase your equity capital. Interest rates are still reasonable and cheaper than new equity financing, even with rising rates.

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Proactively embrace your best customers.

A recession is a perfect opportunity for you as CEO to strengthen your relationship with your biggest and most important customers. Remember they feel the threat of recession too. Customers always want to meet the CEO of the company they bought from so this is an opportunity for you to hit the road, visit customers, and spend time with your salespeople. If you can’t make a meeting in person, meet on Zoom. If you are comfortable selling, get on it. I recently spoke with a founder/CEO with a technical background who told me he had “learned to appreciate sales” even though he was uncomfortable selling at first. If you thought historically your time was better spent on products, it’s time to reconsider: In a downturn, the best use of your time is talking to customers and making sales.

Remember that it is easier and cheaper to sell more to existing customers than to make new customers. This is especially true in a recession as everyone is taking a second look at all their spending. If you are in a B2B business, visiting customers also gives you real insight into how happy your customers are and if you are at risk of customer churn. If you run a B2C business, invest in rewards programs and other initiatives to ensure that your best customers feel appreciated. Risk shifts increase during recessions as companies prioritize spending and withdraw new initiatives. High churn rates have a direct impact on company valuations. As a CEO you are in a unique position to lead by example and your employees will recognize your efforts.

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Stay close to your venture investors.

2020 and 2021 were soft years for venture capital with many venture capital firms bidding to start their valuations at unsustainable levels. These same investors must now decide which of their portfolio companies to prioritize and support as the economy slows. Investors will need to reserve capital for future fundraising rounds for their portfolio companies to succeed.

In 2022, down judges will become more common. As a CEO, admitting that your company has a lower valuation can be very difficult. It’s important to communicate frequently with your venture investors to make sure they see your long-term potential.

Embrace your best employees.

Recession forces employees to rethink their career choices. If employees begin to doubt the viability of the company, they will take calls from larger companies in the market – regardless of their equity – that can pay more in actual income, bonuses, and benefits.

Get ahead of this. Spend time with your best employees to make sure you understand their mindset. Employees are still expected to bring their equity based on the last round of funding, so downgrading raises employee concerns. Losing top talent will have a very negative impact on your company. Managing and maintaining your momentum is important both in terms of retaining your top talent as well as recruiting new talent.

Several times in my career, I have come across this problem by offering additional stock option grants to top employees to ensure they don’t even take recruiting calls. It works. It’s easier to retain top talent than to try to counter-offer once your employees entertain other options.

Highlight and rally around your unique culture.

In my experience as a CEO, culture has been by far the most important determinant of employee retention. Employees know their market value, and most stay with you if they are rewarded and happy and feel they are making a difference. Focus on culture and communicate your company’s unique value proposition.

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At Black Duck Software, an enterprise security startup, we’ve created a culture of equity and learning. Every employee was a shareholder and they considered the company as their own. We created learning and educational opportunities and employees felt that they continue to learn and grow by being part of the company.

Unique and identifiable culture is important to motivate your entire team ready to fight adversity. It may seem counterintuitive to both reduce costs and focus on culture. It is possible because financing unique cultural events is not expensive. It’s really the thought behind the rallies that counts and has an impact on employee morale. At Black Duck, we hosted a Lego Star Wars building competition for our software developers. The event was hugely popular because developers could publicly show off their creativity and have fun, and it didn’t cost much to pull off.

Every company’s culture is different, but now is the time to double down on it. A good culture will help retain talent and ensure you can make it through tough times.

. . .

Recessions are a natural part of the business cycle and companies of all sizes must put up or wither. Startups face a unique challenge because until they become profitable, they rely on outside capital to finance their growth and evolution to maturity. To make it through and emerge even stronger, conserve cash, and pay close attention to your customers, investors, employees, and culture.

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