10 Most Common Questions by Startups During a Downturn

An article we liked from Thought Leader Yin Wu of Pulley:

FAQ for Startups Navigating the Downturn

Understanding the nuances of equity is more important than ever.

We've compiled answers to the most common questions from recent conversations with over 100 startups.

1. What is causing the bear market? How does this affect valuations?

While no one knows what will happen or how bad things will get, here is what we do know:

Inflation is high, the Fed is raising rates, a recession looms, and public tech stocks are down 30-80%. This is different from the first decade of crypto’s existence.
Lower public market valuations impact early-stage startup valuations: Late-stage VCs will price companies based on the IPO price targets in the near term. As public market valuations have collapsed, late-stage VCs have adjusted their valuations down. Early-stage VCs then need to offer valuations that can receive follow-on rounds.
Fundraising is already much slower and valuations much lower: Late-stage valuations have crashed, and early-stage valuations have started to adjust. Some VC firms have paused on new investments, and many are investing very slowly. We have seen terms sheets and job offers rescinded.
The VC ecosystem will take some time (years?) to be as hot as it was. Given the macroeconomic downturn, the LPs who give VC firms money are also cash crunched. This means many VC firms will struggle to raise their next funds, which may result in less capital flowing into early-stage companies in 2023 and 2024. Based on what we are seeing, capital will flow less quickly for the next year, likely two.

The role of the founder is often to be a paranoid optimist. Prepare for the worst and believe in the upside to give your company the greatest chance of making it through any macro environment.

2. What is causing private tech company valuations to crash?

Thank you to Pulley board member Keith Rabois at Founders Fund for his response to this question.

"I’ve been warning of a market crash since October 2021. The situation we’re in now is very similar to the dotcom burst of 2000. For the past few years, we deluded ourselves into thinking things could only go up and to the right. Back in 2000, multiple successive interest rate hikes by the Fed led tech stocks to crash. The exact same thing is happening now. When interest rates are going up, tech stocks will go down. Basic econ 101 tells us that when you raise interest rates, it impacts the discount cash flow formula for valuing stocks, with an exponential impact on further out years. Because tech companies tend to have longer paths to profitability, many founders are seeing their present valuations disproportionately cut. With publicly traded tech stocks down 50-90%, it’s become impossible for private companies to escape their public market comps (e.g., any crypto company inevitably is compared to Coinbase, which is down 85% from its highs)." - Keith Rabois, Founders Fund

3. How long will this downturn last?

It is unclear how long this pullback will last. It may be a few months like 2020, 18 months like 2008, or a brutal three-year correction like 2001. Understand your financials, and plan for all scenarios.

4. When should I think about fundraising in a downturn?

In order to survive, you must maximize your runway. Get to at least 24 months of runway, and ideally 30 months. You will need to raise 6-9 months before you run out of capital; if you have only 18 months of runway, you will need to raise in Spring 2023, in a potentially unfavorable fundraising climate.

If you have +24 months of runway…

Once you have 24+ months of runway, you are in one of two camps:

Pre product-market fit - Focus on getting to product-market fit. Nothing else matters. Expect that the next funding round will be harder. Multiples will decrease, and the promise of future growth will not be enough to raise.
Post product-market fit - Focus on...