5 Ways Startups Can Prepare for a Recession

Startups face unique challenges during economic recessions. They are typically still unprofitable and therefore dependent on outside funding—and are therefore especially exposed when macroeconomic conditions change. To get through a recession, startup CEOs must go on the road and talk to customers. They should also focus on preserving their company culture and retaining the best employees. And they want to do whatever they can to extend their runways—including taking out a line of credit.

With stocks down 20% from their highs, we are officially in a bear market. Many economists predict that 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 a recession and survive?

I have spent the last three decades in the software industry, including three stints as CEO as well as serving on the boards of 10 private companies and as a consultant 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 much more difficult to raise capital. You need to extend your runway or your “cash-out date”, so plan to live on the capital you have. You only spend money to make your product or service better or to drive new sales. No more “nice to have” costs: Increase returns on new initiatives, prioritizing only those with a short-term chance of success.

In recessions “cash is king,” so you want to make sure you have enough to tide you over for 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 a CEO to strengthen your relationships with your biggest and most important customers. Remember they are feeling 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 vendors. If you can’t have a meeting in person, meet on Zoom. If you are uncomfortable selling, get over it. I recently spoke with a founder/CEO with a technical background who told me he “learned to appreciate sales” even though he was uncomfortable selling at first. If historically you thought that your time was best spent on the product, it’s time to reconsider: In a crisis, your best use of time is to talk to customers and make sales.

Remember that it is easier and cheaper to upsell to existing customers than to upsell to new customers. This is especially true in a recession as everyone is taking another look at all expenses. If you are in a B2B business, visiting customers also gives you a real insight into how happy your customers are and whether you are at risk of customer churn. If you run a B2C business, you invest in rewards programs and other initiatives to make sure your best customers feel valued. The risk of volatility increases during recessions as companies prioritize their spending and pull back on new initiatives. High turnover rates have a direct impact on company valuations. As a CEO you are in the unique position to lead by example and your employees will recognize your effort.

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Stay close to your venture investors.

2020 and 2021 have been boom years for venture capital and many venture firms have bid up startup valuations to unsustainable levels. Those same investors must now decide which of their portfolio companies to prioritize and support as the economy slows. Investors will have to reserve capital for subsequent rounds of fundraising for the portfolio companies to see them succeed.

In 2022 down rounds are 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 venture investors to ensure that they see your long-term potential.

Embrace your best employees.

Recessions force employees to rethink their career choices. If the employees start to doubt the viability of the company, they will take the calls from bigger firms in the market – regardless of their equity – that can pay more in current income, bonuses and benefits.

Pick this up. Spend time with your best employees and make sure you understand their mindset. Employees always assume that their equity share is based on the last round of funding, so down rounds create employee angst. Losing top talent will have a very negative impact on your company. Managing and maintaining your momentum is critical both in terms of retaining your top talent and recruiting new talent.

Several times in my career I have caught this issue by offering additional stock option grants to the best employees to make sure they didn’t even take the recruiting calls. It works. It’s much easier to skip retaining top talent than it is to try to counter-offer once your employees are entertaining 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 will stay with you if they are compensated and happy and feel they are making a difference. Focus on culture and communicate your company’s uniqueness and 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 considered the company theirs. We created learning and education opportunities and the employees felt that they continued to learn and grow by being part of the company.

A unique and identifiable culture is critical to motivating your entire team ready to fight through adversity. It may seem counterintuitive to both cut costs and focus on culture. It is possible because the financing of unique cultural events is not expensive. It’s really the thought behind the meetings that counts and has an impact on employee morale. At Black Duck we ran a Star Wars lego building competition for our software developers. The event was very popular as developers could publicly show 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 helps retain talent and ensures you’re able to get through tough times.

. . .

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

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