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“How to Lead Your Startup During the Economic Downturn (part 1)”

A short discussion between Midstage Institute Startup Coach Roland Siebelink & Doug Miller.

Startup Coach Roland Siebelink & Doug Miller

If you want to listen to part 2 of “How to Lead Your Startup During the Economic Downturn,” you may click here.

Show Notes

The recent economic downturn has already had a profound impact on tech startups. Many midstage companies are struggling to raise funds or receive valuations they view as fair, leaving many to wonder how they’ll survive the next year or more and come out of the other side of the downturn intact.

With startup leaders in need of guidance, Midstage Institute co-founders Roland Siebelink and Doug Miller have put together a two-part podcast about what startup leaders can do during the current downturn and how to lead during lean times. In the first part of their conversation on the Midstage Startup Momentum Podcast, Roland and Doug talk about their experience in past economic downturns and how founders can respond to the current situation.

Transcript

Roland Siebelink: Hello and welcome to the Midstage Startup Momentum Podcast. I am Roland Siebelink, founder and CEO of the Midstage Institute. And I’m here with co-founder of the Midstage Institute, Doug Miller. Hello, Doug, my friend.

Doug Miller: Hello, Roland, my friend. How are you? And hello to everyone listening to the podcast out there. I think this will be a very engaging conversation. And hopefully, we’ll have a lot of useful tidbits for all of you founders, CEOs, and executives steering your startup and SaaS companies through these turbulent storms.

Roland Siebelink: Yes, that’s exactly the reason why we decided to just do a conversation between the both of us. Normally, we have external guests on our podcasts, but today we want to have an in-depth discussion of the downturn that is currently happening, how to respond to it, and how to be a good leader in the lean times.

Doug Miller: Exactly. And these are conversations we’re having with many of our clients today. A few of them are not being impacted. But many of them are being impacted by this downturn and these lower valuations. And so, what we really want to do is bring the best practices we’re working with all of them about and what we’re seeing have great traction out to all of you so that your companies can not only survive but also thrive through this downturn and come out even stronger.

Roland Siebelink: Yeah. And for those that may be new to the Midstage Institute, maybe it’s a good reminder, Doug, to tell them what kind of companies we focus on, in particular, so that we are all sure that the content we share here today is actually relevant to the people listening to this podcast.

Doug Miller: Absolutely. We work with technology companies, SaaS hardware and other associated companies across the United States and internationally. And we help them from late Series A through - depending on how large - Series D. Help them scale and get their companies to operate as efficiently and as effectively as possible, and to overcome all of those growth pains that both Roland and I have encountered in our combined 50-plus years in startups in Silicon Valley and in Europe.

Roland Siebelink: Probably over five unicorns under our belt and many failures as well. Of course, this is still the startup world, so failures are going to happen. If you are listening here as an early startup founder - for example, pre-product-market-fit - then this advice does not apply to you. Some of it may, but generally, this is really focused on those companies that already have product-market-fit, that have had sizable sales for a few years. Most of them will be between the $5 and $15 million ARR. Make sure that this actually applies to you because our first learning at the Midstage Institute is that advice that applies in one phase may not actually apply to you in a different phase.

Doug Miller: Very, very well said. And I definitely think that, especially as you’re on the lower end of that revenue stream, survival becomes really critical during these downturns. And especially if you’re a first-time founder, you may have not experienced the.com bubble burst in 2000, or the great recession of 2008, or the downturn during COVID in 2020. Roland and I have fortunately and unfortunately experienced all of those at various stages of companies. The first thing we want everyone to be aware of is that winter is here, spring will come, and the question is, will your company survive until spring? And that’s what we want to make sure that not only are you able to survive through this winter but that when you come out, you’re going to be in a healthier place than all of your competitors.

Roland Siebelink: Absolutely. Let’s stop talking about how old we are; let’s delve into this downturn. You collected quite a few articles, Doug, around the bubble bursting. Of course, we’ve had many conversations too. What’s the overall take would you say of the press, the popular analyst, looking at the tech sector?

Doug Miller: sAfter the small recession in 2020, during COVID, where everything fell, tech really led the market back with crazy high valuations relative to today. Companies got a lot of money and the funding environment was very easy. Now valuations are down substantially. VC money is slowing down substantially. A lot of the very large funds are stopping their VC investments to figure out what’s going on. Effectively, raising capital in the next six to nine to potentially 12 months is going to be incredibly difficult. We’re advising most of our clients that you likely will not be able to raise capital. You need to find a way to increase your runway.

Here’s a point where Roland and I disagree. If I was to bet, I would be thinking, how do I make sure my runway extends at least 12 months and how in six months can I reevaluate that and make sure I can extend my runway out to another six months or 12 months past that point? I think that Roland in many things that he’s read, he’s a little bit more pessimistic and thinks that companies really have to batten down the hatches and make sure they can survive for more than just 12 months. Roland, what’s your take on that?

Roland Siebelink: I would add a bit of nuance to that. I would say three questions come to mind. The first is how do you define a crisis? And is this really a time when it’s impossible to raise funds for all but the very best companies? Caveat, every founder thinks they are the very best companies. But this is your investors’ call, not yours. It is going to be really hard. I agree with Doug on that.

I agree with you that most likely within a year, it’ll be easier to raise funds again, but not at a valuation you’ll find in any way reasonable. And I think that most likely we’ll still be looking at valuations that are about half of the maximum that we were used to, maybe even a little bit lower. If you are in a bind here and you need money right away, then definitely you have to find a way to stretch that runway for about a year until you have a chance to raise money again. But even then, you would want to have a very good plan about how much money you actually need to raise because it may come very expensive to you.

In general, if you can stretch it in any way to 24 months or even to default alive - or default profitable as Y Combinator sometimes calls it - you may be far better off, even if it doesn’t actually drive the hyper growth that you were used to working toward up to now.

Doug Miller: Very well said, Roland. Just so you all know, Roland meant 24 months, not 24 years. He’s saying if you could extend your runway to 24 months - and I do agree with this - you’re likely to get much better valuations for your company. Primarily for two reasons. One, I think the fundraising situation will be back to normal, maybe not the normal of 2020, 2021, or early 2022, but back to the normal 2016 or 17.

Secondarily, I think that if you’re able to survive and thrive and extend that runway, it will clear a lot of your competitors out of the market because they will not be there, which will mean you’ll have a much easier route to seize more market share in a credible way, which will also help with those valuations.

I know many founders, Roland, we’ve worked with over the past few years who have been on their third or fourth or fifth company have said that 2000 was a blessing in disguise. It cleared a lot of the bad companies out. Same thing with 2008. Unfortunately, I think 2000 wasn’t long enough to really clear it out. But the companies that come out of this the next 12 to 24 months that are stronger and are better positioned and have the capital they need are really going to be able to be the dominant players in their markets going forward. And we hope that some of you that are listening take some of the things we’re going to talk about today and get there.

Roland Siebelink: Absolutely. And I think that there are also opportunities in a downturn. And we’ll talk about that a little bit later in this recording. But I would also say - coming back to a little bit of historical context, Doug made an extensive point about how old we are, let’s just say how experienced - and I would want to say to those that are maybe at their first startup or maybe late 20s, early 30s, that the reality you’ve learned so far is actually in two ways being ahistorical.

First, the fact that there was a very long high of about 12, 13 years of extremely high valuations and ever-rising valuations. That’s historically not actually what we’ve seen in the venture capital area and the startup community. What was more normal in the past is that there would be a business cycle of a down and an up in about a 10-year cycle, which is why most VC funds have a 10-year horizon. And we just haven’t seen that historically. And I want you to be aware that that’s historically an exception.

And the other big exception that we all lived through last year was the extremely vast crisis of COVID, which for tech turned out more of a blessing in disguise. And that is something that I don’t think we can expect with more of a normal economic downturn as we see right now. When I say be pessimistic, it’s primarily to guard against that optimism of, “Okay, if we just hunker down for three months, that’ll be enough.” I don’t think that’s going to be the case here.

Doug Miller: I could not agree with you more. And just to add some context to this, just talking about the US economy, the average recession lasts 10 months. That means at least for 10 months, things are likely to be suppressed. The great recession lasted 18 months. But again, your evaluations are going to lag six or 12 months after an economic downturn happens. And they may never get back to what you view as the current normal.

Roland Siebelink: Yes, exactly. And we’ll talk a little bit about how to maintain yourself as a founder in those changing times. The last thing I wanted to come back to, Doug, is this argument that people say it shouldn’t matter because VCs have raised so many funds and it’s all dry powder waiting to be invested. Why does the economy matter to them if they’ve already raised all that money? Can we talk about that for a second?

Doug Miller: Yeah. There’s a couple of things. With interest rates rising, there are other places people can make money. There’ve also been a number of spectacular failures and funds have to make returns overall. And investors can also choose not to continue to fund and pull their money out of VC funds. And many of the VC funds have announced just in the last couple of weeks that they’re not making any investments in the short-term. This is a major change, and honestly, it doesn’t matter how experienced Roland and I are, in our adult lives, we have not experienced inflation. That’s another wild card that’s coming into this whole environment.

Roland Siebelink: Basic economics, of course, if inflation is higher and interest rates are higher, not only can you make more money in other things but also businesses that promise long-term payoffs, such as typical tech startups, the cost of money will make sure that those long-term payoffs are worth a lot less than they were before. The valuation models are changing.

I have not been a VC, but I’ve worked with people who are, and they say even if a fund gets committed does not mean the cash is in the bank. What they do is they make a capital call every time they want to announce an investment and then their investors - or limited partners as they’re called - have to actually transfer the money every time a new investment is being pitched to them. And while legally, maybe they might be obliged, in a circumstance like this, no VC is going to put pressure on their limited partners to actually transfer that money. And that’s why, when you hear dry powder, that’s not actually dry powder in the bank. It just means an overall commitment that the VC is willing to call limited partners. And that’s not going to happen in these times when everything is so insecure.

Doug Miller: Very well said. That’s a big nuance that founders sometimes miss because they think VCs have the money in the bank. And they do have it in their partners’ banks, but not necessarily in their accounts to fund companies. Very well said.

Roland Siebelink: Yes. And the juster partners’ capital is not going to fund it, especially not if the limited partners are not following; it would undermine the entire business model.

We’ve taken away nuance and compared it with COVID. And yes, we do agree that it is seasonal, so in the end, there will be a springtime. But I think we’ve also made clear you cannot just wait and sit down and wait until springtime returns. You have to take action in order to actually proactively reach springtime and make sure the company still survives at that time.

Doug Miller: Yes, unquestionably. Are we getting to our crisis framework now, Roland?

Roland Siebelink: Yes, let me quickly pitch that. We had a book coming out in the early days of COVID. You can recognize it by the mask that has now become so prevalent. It’s called Leading Your Startup Through CRISIS. And we introduced areas like the crisis framework - CRISIS - which really stands for communicate, reassess, instruct, sustain, inspire, and then spot opportunities. Part of this still applies in this crisis, but this was written very specifically for COVID. It can be an inspiration. At the same time, I would say we’ll add some nuance to that framework as we talk through the recording further down in this podcast.

Doug Miller: Roland, as you think about the founders we’re working with, what’s the first thing you’re helping those founders work through.

Roland Siebelink: It really depends on what angle they come to us with. What we often make them aware of is that they need to be in charge of themselves before they can be in charge of the company. What I really mean with that is that you need to find a degree of certainty and a degree of openness in yourself in order to maintain yourself as a credible leader in this time.

It’s easier to explain by contrasting with what you should not be or what you should not do. Of course, none of these examples are any of our clients - let me make that very clear because they know better - but we sometimes see founders who in the face of a big valuation slump will maintain that this is all BS and essentially their company must still be worth the very same as it was before, even in the face of the entire economic framework changing, every investor starting to value things differently. If you are not in touch with reality changing, then that really undermines your credibility as a founder.

Of course, we’re all loss averse as humans. It can really be painful, literally painful to have to give up on this dream of, “I was once worth more than a billion dollars,” as an example. But if the situations change, if you want to remain an effective leader, you have to also be able to see that what you play with is changing your environment, and in order to respond to it well, you have to be aware of that environment and properly reassess it. Self-management in a way is one of the very first requirements of a leader so that you can work with that new environment and also communicate effectively to people what you see changing and how you want their behavior to be different.

Doug Miller: Well said. Many of the clients I’m working with are coming to us, saying, “Okay, I’m projecting 20, 30% fewer revenues, I’m projecting lower growth, these types of things. What do I do next?” But then many - in fact, one company that I’m an angel investor in, they are not seeing that. And so the conversations we’re having with them outside of the practice are around, “Hey, is it reasonable that your valuation is not going to change?” Are you really a unicorn right now in this market? And the answer is no.

Ultimately, the answer is no. And this is where if you’re not able to understand the stormy seas that are coming here, you can’t be a credible captain for your ship. One, you’re not going to turn into the big waves. Two, none of your crew is going to follow you. As Roland said, you have to be self-aware of what is happening and how this has changed your customers, your company, your valuation, and that then leads to you having to change how you lead your team and the company through this coming crisis.

You’re going to change with the changing world. What’s next, Roland?

Roland Siebelink: Well, I would say that part of that self-management is also don’t wait with communicating to your team until you’re a hundred percent sure. It’s okay to communicate where you have your doubts, where you’re not sure yet. But in times of crisis, people will want to hear from you, which is why that CRISIS framework I mentioned before started with the C of communicate. I think we even said, communicate, communicate, communicate because it is so important in these times.

Many of the startups we work with in times of crisis start doing weekly video calls posted on Slack or weekly All Hands or whatever the case is that people - even throughout the world in distributed offices or working from home - can all see and hear what the CEO is thinking. Even if that guidance is not all that clear yet and they’re just sharing that they’re not sure. But what they are communicating is I know the world is changing, I am reassessing, we are on it with people, and we’re doing our best to survive through these bad times and make sure everyone is still on board at the end if we can.

Doug Miller: Very well said. And I think the key thing there is to project confidence in a changing environment and that you and the leadership team are reassessing and are planning and that everybody should stay focused on how to drive profitable growth, how to drive cash in their own individual areas as the overall environment is being reassessed by the leadership team.

And definitely - this is really important - one leader we work with I was talking to do today, celebrate the small wins every week. If you get a big renewal, if you’ve got an upsell, if you turn a one-year contract into a three-year contract, celebrate those small things, showing that there’s still good momentum with your company that people can tangibly actually feel ,so they feel like, “Okay, maybe the sky is falling everywhere else, but we are still making progress going forward.” That way, you can both have that credibility of there are small wins coming and you’re reassessing because you’re a great leader who is acknowledging the world has changed. We’re going to have to make some changes along with that. But we’re also winning right now as we move forward in the current environment.

Roland Siebelink: Yes. And I think that a point of confidence - of course, confidence is supremely important. And it would be confidence about I can handle this situation. We can survive this situation. I would say, don’t try to optimize for overconfidence in the sense of we’re great and we’re killing it and that’s it. It is winter and you have to acknowledge that it’s winter and that not everything is going to be as easy as it may have felt before while it was summer or fall.

Doug Miller: Very, very, very well said. We’re talking about communication. We’ve already talked about the dry powder and VC funding. I think this gets us that growth was king in the previous world, I think cash is now becoming king.

Roland Siebelink: Yes. And this is probably, especially for those people who have not lived through previous VC downturns yet, they feel that in the startup world, all that matters is growth. And that is true when it’s an upswing. But when it’s a downswing, then suddenly everything starts mattering more on the bottom line. Now we’re starting to see calls for how can you generate more cash? How can you have less growth, especially when it’s unprofitable in the short term. Now you have to start focusing on things like what’s the return on investment, how quickly does all of this payback, how quickly can I get to positive cashflow.

I was just reading a blog post this morning that said VC’s are now trying to focus the remaining investments they still envision - if there are any - on those companies that are able to get to 30% free cash flow in a very short timeframe. Instead of your path to tripling, tripling, doubling, doubling, doubling, now the question is going to be what’s your path toward that 30% free cash flow. And that really means rejigging a lot of what you do in your company from a total optimization on just increasing that top line at no matter what cost to what is that core, what do we do well, what can we do profitably, and what’s all the other costs that we’ve generated that will not contribute meaningfully to our bottom line - not our top line, bottom line - in the short term?

Doug Miller: Very well said. And as we did mention before, the world has changed. We’re not looking for 300% growth. We’re looking for 30% free cash flow. That’s a big, big, big change for everyone in the market right now. And that not only means looking at every customer, sometimes you have very large or very promising customers who are very unprofitable. You may have to have a hard conversation with them. If you’re losing money on a customer, this is not a time where you can afford to keep them. You have to have those hard conversations. You should try and work with them. But the great thing here is you can have that conversation with customers; everyone’s aware of this.

The other thing that we recommend is you go to all of your vendors and ask for a 20% discount. There’s no reason not to go and ask them all for it. Nobody’s going to question why you’re asking it. They may not give it to you, but it can’t hurt to ask.

Roland Siebelink: And don’t just think because you used to just stack and tear on the growth rate, maybe didn’t quite make double, triple, triple, double, double, double, but you are growing 60, 70% a year, that will not necessarily save you. That same blog post I referred to this morning said that 30% free cash flow is where VCs will concentrate all of their investments, even actively withdrawing investments from the second tier investments that they have if they don’t see a fast path to a free cash flow. They also make the point that some of the actual growth champions may actually have the hardest time to get through free cash flow because they’ve optimized so much on just increasing that top line every time. This is truly a total course change, and it will require a lot of creative thinking, a lot of total perspective changes in your team.

Doug Miller: We talk a lot about sacred cows with our client base. What are the sacred cows? What are the things that you would never think about cutting? What you would never think about touching; they’re central to your business. If they’re not generating cash, they shouldn’t be at your company going forward, at least in the short term.

Roland Siebelink: Yeah. This is the famous Winston Churchill saying, never let a good crisis go to waste. All those things that have frustrated you over the years - why do we keep spending money on this project that never seems to be driving a return but it’s somebody’s pet project. Or we always tell ourselves this is going to work out in the next year, even if it hasn’t for the last three or four, that’s what we call a sacred cow. Those things where you know it’s better not to challenge them because we’re just going to end up in a huge fight and nothing’s going to happen. Times have changed there too. And this is the time to start saying, “Folks, what are we doing? Why are we still spending money on that? It’s good money going after bad. And in these times we simply cannot afford that anymore.”

Doug Miller: Very well said. It could be three of your customers who provide a lot of your revenue, but it’s not profitable revenue. It may be that you have a suite of five products and two of them are profitable and three are not. You really have to look at what can you do at your core that’s going to generate cash so you can survive this winter, so when you come out the other side, you can dominate your market. Right now, it’s about survival.

Roland Siebelink: It is. And just to state the obvious perhaps - but I see many companies that have never done this - all your charts so far have probably been just about top-line revenue. You look at who generates the most revenue and you think of them as your most profitable customers. But I will tell every startup out there that the actual profitability numbers can be vastly different.

We’ve often seen startups that think these are the most important customers. And when they actually do the calculations, because of all the custom deals they did for them or the extra features or other little short cuts in their systems - these customers actually turned out while they generate a lot of revenue, a lot of top line, the costs involved are actually so much bigger that they’re actually detracting from the profit, let alone from the cashflow. This is very un-intuitive to people, especially if they haven’t done business training or gone through finance courses.

Work closely with your CFO or your VP of finance. Listen to them - for a change, I might add. Listen to them for a change and have them do an analysis on a profitability basis rather than on a revenue basis. It will generate a vastly different perspective and you’ll be surprised how much of your good money you’re throwing after bad, now that your perspective is changing.

Doug Miller: And just to highlight the emotional part of that, Bismarck Lepe, who is the CEO of Wizeline, wrote a blog - I believe it was in 2016. He actually was an intern of mine when he was an undergraduate at Stanford, much much more talented. But he said wintertime decisions suck. You’re going to have to make hard decisions. They suck. If the decisions you’re making aren’t hard, you’re not making the right decisions.

Roland Siebelink: Absolutely. Easy decisions are not going to cut it in this case. That’s why we say - together with Winston Churchill - don’t let a good crisis go to waste. This is the time to make hard decisions and where everyone also respects that you’re making hard decisions. In a crisis, you can push through a lot more that wasn’t possible before.


Roland Siebelink talks all things tech startup and bring you interviews with tech cofounders across the world.

Our coaches have a very clear and measured approach to help leaders think objectively about where their compnay is, and where they want it to be. They were able to walk the team through each of the steps and show how they connected. The outcome was a clear consensus for the team on what the key issues are that need focus in the coming months.

Mark Wochos, Chief Information Security Officer, VEDA Data Solutions, Madison, WI