In a letter to its portfolio startup founders, marquee Silicon Valley startup incubator Y Combinator has said the economic situation does not look good and advises startup founders to take money from investors even on terms of their previous rounds, if available.
“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,” Y Combinator said.
The startup accelerator also advised its founders to cut costs and extend their runways before they are out of money. Y Combinator said that the economic situation is unpredictable but will be bad in the coming days.
Y Combinator, commonly known as YC, said, “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.”
Default alive means staying on track to make a startup profitable with its current resources.
Y Combinator also advised founders to ensure that their company survives, if they are not able to raise money even for the next 24 months. YC warned that the future fundraises will be ‘much more difficult’
The startup incubator also told companies that are looking to raise funds in the next 6-12 months to reconsider fundraising as it said chances of them being able to raise funds successfully are ‘extremely low.’
Y Combinator said the poor public market performance of tech companies is impacting venture capital (VC) investing. “VCs will have a much harder time raising money and their LPs (Limited Partners) will expect more investment discipline,” said YC.
According to YC, during economic downturns, even the top-tier VC funds with a lot of money slow down their deployment of capital, and 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,” Y Combinator said. Investors also reserve more capital to backstop their best-performing companies, which reduces the number of new financings.
The startup incubator’s comments come at a time when aggressive tech investors including Japan’s SoftBank Group and New York’s Tiger Global are significantly reducing their exposure to high-growth companies after the two venture capital firms reported record losses on their VC funds. Moneycontrol reported last week that SoftBank will be cutting investments in 2022 to a fourth compared to 2021.
However, Y Combinator pointed out that economic downturns often become huge opportunities for the founders who quickly change their mindset and make sure their company survives. YC also said that startups could often pick up significant market share in an economic downturn just by staying alive.
YC argued that this slowdown will have a disproportionate impact on international companies, asset-heavy companies, low-margin companies, hard tech, and other companies with high burn long time to revenue.
Interestingly, it said that the number of meetings investors hold does not 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,” added YC.
