Y Combinator has warned founders to buckle up and brace for a funding slowdown as venture capital firms start to sweat amid the global markets turmoil.
The Silicon Valley-based startup accelerator, which has backed over 3,000 startups around the world, including India’s unicorns such as Razorpay, Meesho, Groww, and others, wrote a letter to founders of startups in its portfolio, cautioning that “future fundraises will be much more difficult."
"If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn,” the letter said. “The safe move is to plan for the worst."
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The note comes at a time when technology stocks have been hammered amid a wider market rout, which has led to a ‘mauling’ of the world’s leading venture capital investors — Tiger Global and SoftBank. The tech sell-off is reported to have punctured Tiger Global’s holdings to the tune of $17 billion, while Softbank has reported a $27 billion loss.
As a consequence, for late-stage startups that were looking to raise larger funding rounds this year, the outlook looks bleak. Several unicorn startups in India are issuing pink slips to employees to cut costs and pave a longer capital runway.
Earlier today, IPO-bound automobile marketplace Cars24 fired close to 600 employees. Edtech unicorns Vedantu and Unacademy have each laid-off over 600 employees over the last two months.
"The US Fed has started tightening monetary policy with a 50 bps interest rate hike and business risk premium /discount rates have gone up globally, which has had a significant negative impact on valuations of listed loss-making but growth-oriented start-ups," said an IVCA-EY report.
"This is expected to have a spillover effect on the private capital side as well. Both start-up valuations and deal closures could see some slowdown in the coming few months," it added.
On a yearly basis, venture capital-led startup investments declined by 50 percent to $1.6 billion across 82 deals in April.
CNBC-TV18 reviewed the letter sent by Y Combinator to its portfolio founders. Here's a full copy of the letter, which has been titled, "Economic Downturn".
Greetings YC Founders,
During this week we’ve done office hours with a large number of YC companies. They reached out to ask whether they should change their plans around spending, runway, hiring, and funding rounds based on the current state of public markets. What we’ve told them is that economic downturns often become huge opportunities for the founders who quickly change their mindset, plan ahead, and make sure their company survives.
Here are some thoughts to consider when making your plans:
1. No one can predict how bad the economy will get, but things don’t look good.
2. The safe move is to plan for the worst. If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days. Your goal should be to get to Default Alive.
3. If you don't have the runway to reach default alive and your existing investors or new investors are willing to give you more money right now (even on the same terms as your last round) you should strongly consider taking it.
4. Regardless of your ability to fundraise, it's your responsibility to ensure your company will survive if you cannot raise money for the next 24 months.
5. Understand that the poor public market performance of tech companies significantly impacts VC investing. VCs will have a much harder time raising money and their LPs will expect more investment discipline. As a result, during economic downturns, even the top-tier VC funds with a lot of money slow down their deployment of capital (lesser funds often stop investing or die). This causes less competition between funds for deals which results in lower valuations, lower round sizes, and many fewer deals completed. In these situations, investors also reserve more capital to backstop their best-performing companies, which further reduces the number of new financings.
6. This slowdown will have a disproportionate impact on international companies, asset-heavy companies, low-margin companies, hardtech, and other companies with high burn and a long time to revenue.
7. Note that the number of meetings investors take don’t decrease in proportion to the reduction in total investment. It's easy to be fooled into thinking a fund is actively investing when it is not.
8. For those of you who have started your company within the last 5 years, question what you believe to be the normal fundraising environment. Your fundraising experience was most likely not normal and future fundraises will be much more difficult.
9. If you are post Series A and pre-product market fit, don’t expect another round to happen at all until you have obviously hit product market fit. If you are pre-series A, the Series A Milestones we publish here might even turn out to be a bit too low.
10. If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan.
11. Remember that many of your competitors will not plan well, maintain high burn, and only figure out they are screwed when they try to raise their next round. You can often pick up significant market share in an economic downturn by just staying alive.
12. For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn
Best,
YC
PS: If for whatever reason you don’t think this message applies to your company or you are going to need someone to tell you this in person to believe it... please reassess your beliefs on a monthly basis to make sure you don’t drive your company off a cliff. Also, remember you can always reach out to your group partners.
First Published: May 19, 2022 10:42 PM IST
