5 Ways Startups Can Prepare for a Recession

Startups face unique challenges during economic downturns. They are usually not yet profitable and therefore rely on external funding – and are therefore particularly exposed when macroeconomic conditions change. To get through the recession, startup CEOs need to walk and talk to customers. They should also focus on maintaining company culture and retaining top employees. And they should do whatever they can to extend the runway—including taking out lines of credit.

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

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

Take steps to expand your runway. Now.

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

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

Proactively embrace your best customers.

A recession is the perfect opportunity for you as a CEO to strengthen your relationship with your biggest and most important customers. Remember that they are also feeling the threat of recession. Customers always want to meet the CEO of the company they are buying from, so this is an opportunity for you to visit, visit with customers, and spend time with your sales force. If you can’t have an in-person meeting, meet on Zoom. If you are not comfortable selling, get over it. I recently spoke to a founder/CEO with a technical background who told me that he “learned to appreciate sales” even though he didn’t feel like selling at first. If you used to think that your time was best 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 land new customers. This is especially true in a recession because everyone takes a second look at all expenses. If you are in a B2B business, visiting customers also gives you real insight into how happy your customers are and whether 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 are appreciated. The risk of churn increases during a recession as companies prioritize spending and pull back on new initiatives. A high churn rate has a direct impact on a company’s valuation. As CEO you are in a unique position to lead by example and your employees will recognize your efforts.

Stay close to your venture investors.

2020 and 2021 are bubble years for venture capital and many venture capital firms are bidding startup valuations to unsustainable levels. Those same investors now have to decide which portfolio companies to prioritize and support as the economy slows. Investors need to set aside capital for the next round of fundraising for portfolio companies to see them succeed.

In 2022 following rounds which is becoming more common. As a CEO, admitting that your company has a lower valuation can be very difficult. It is important for you to communicate frequently with your business investors to ensure that they see your long-term potential.

Embrace your best employees.

The recession forced employees to rethink their career choices. If employees begin to doubt the company’s capabilities, they will receive calls from larger firms in the market – regardless of their equity returns – that can pay more in current earnings, bonuses, and benefits.

Get ahead of this. Spend time with your best employees to make sure you understand their mindset. Employees always consider their equity stake based on the last round of funding, so the following rounds create employee angst. Losing top talent will have a very negative impact on your company. Managing and maintaining your momentum is important in terms of keeping your top talent as well as recruiting new talent.

Several times in my career I got ahead of this problem by offering additional stock option grants to top employees to make sure they didn’t even pick up recruitment calls. It works. It’s easier to move forward to keep top talent than to try to counter-offer once your employee entertains other options.

Emphasize and rally around your unique culture.

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

At Black Duck Software, an enterprise security startup, we create equity and a culture of learning. Every employee is a shareholder and sees the company as their own. We create learning and educational opportunities and employees feel they continue to learn and grow by being part of the company.

A unique and identifiable culture is essential to motivating your team to fight through adversity. It may seem counterintuitive to both reduce expenses and focus on culture. It is possible because financing unique cultural events is not expensive. It’s really the thinking behind the meetings that counts and has an impact on employee morale. At Black Duck we hold a Star Wars lego building competition for our software developers. The event is very popular because developers can show their creativity in public and have fun, without incurring huge costs.

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

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Recessions are a natural part of the business cycle and companies of all sizes must weather or wither. Startups face unique challenges because until they become profitable, they rely on outside capital to finance their growth and evolution to maturity. To break through and emerge stronger, save money, and take care of your customers, investors, employees, and culture.

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