A Bumpy Road Ahead

January 21, 2019

 

Cautiously opportunistic – is going to be the tone for 2019. The world has enjoyed almost a decade of global economic expansion, however, we are now seeing early indicators of a potential economic slowdown. I am no economist but if you have been following the stock market volatility, yield curves, trade wars, potential US government shutdown, big tech backlash, business sentiment indicators – all point to higher economic risks over the next 12 months.

 

Many investors are sounding the alarm bells – sharing links to Sequoia’s infamous RIP good times deck. I agree that the road ahead will be bumpy but the current data does not suggest an imminent economic crash (barring an outlier event). So, what are the economists predicting? Depends on who you ask. JP Morgan thinks less than a 30% chance; Gary Shilling, who correctly predicted the housing crash of 2008, thinks greater than a 60% chance of a recession in 2019, and most likely in Q4-2019. It is impossible to predict the timing of a recession but it appears we are nearing a peak:

 

 

Irrespective of how quickly a recession arrives, it will be prudent for startups to evaluate risks to their customer acquisition, operations/hiring, cash flow and fundraising plans for 2019-2020. Some startups will be unscathed (especially the solutions embedded in key customer workflows) but many will feel the pain as customers tighten up spending and VCs demand higher performance metrics/benchmarks for investments.  

 

What happened in the US venture sector during the last economic cycle?

Venture funding isn’t necessarily recession proof. It took about 3 quarters after the 2008 crisis hit for the VC funding to find its bottom (not much of a bottom in Q2-2009 if you ask me but it’s relative). The conclusion is while the VC funding slowed, it did not disappear in 2008-09. VCs are longer-term investors and as a result, the best investors took advantage of the down cycle and invested in companies who benefited from the upswing. In addition, it is important to draw a distinction between an economic cycle and a tech cycle. The 2008-09 period can also be seen as the early stage of the last tech cycle (convergence of cloud computing, mobile and social media) when several major unicorns were born including AirBnb, Evernote, Twilio and Uber.

 

 

Currently, capital is available and plentiful (including increasingly more US capital) for Canadian startups with good fundamentals. The good news is that several new and existing venture firms recently announced new funds or are in the process of closing their next funds (i.e. they will be investing out of fresh pools of money). Bad news: these are new funds with 3+ years of investment cycle. Hence, depending on the timing and severity of a down cycle, they may or may not be in a rush to make new investments. Tip: Look into where VCs are in their fund’s investment cycle when you start taking investor meetings for your next round.

 

So, what now? Start preparing and let us know how we can help.

 

  • Scenario planning. Stress test your 2019-2020 cash flow model by running different financial scenarios, e.g. negative, neutral, positive.

 

  • Take advantage of the current positive funding environment and fundraise ASAP if your business is delivering on milestones and/or you may run out of cash within the next 12 months. And, consider raising more than you may need.

 

  • Strengthen fundamentals. You may need to show a higher level of traction/metrics in order to raise financing in a down cycle.

 

  • Secure access to alternative sources of funds, e.g. non-dilutive grants, line of credit, etc.

 

  • Don’t forget to also identify opportunities to take advantage of a down cycle (if you have the cash), e.g. acqui-hire, M&A with a competitor, accelerate in a specific market, etc.  

 

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