Y Combinator advises startups to prepare for an economic downturn

Y Combinator advises founders to prepare for economic downturn - Startup Lagos

Lower valuations

Even as the public and private markets stumble clumsily, in the wake of huge market shocks, many VC firms are warning of looming turbulence and lower valuations. In the wake of these warnings, many startups on the global market have been subjected to corrections on their valuations, as startups face the heavy hammer of adversity in these few months of 2022. 2021 had been a breeze, with many records broken across geographical sectors. However, this year has brought with it a good deal of storms and tough situations.

Sriram, of Reuters, had pointedly stated that in the lethargy of this slowdown, not seen in at least five to six years, many startups were going to face the heat, not excluding unicorns. He quotes Anand Lunia of India Quotient, a venture capital firm in India who had pointed out that there would be a proliferation of zombie unicorns – companies that are unicorns but have no business models, and have stopped hiring; not dying, but irrelevant to the market.

Heavy headwinds from growing investor skepticism on the back of startup scandals have rocked global startup ecosystems. Just like the story of corporate scandals had rocked the business world, and brought down the misleading shareholder-supremacy theories of Milton Friedman, today’s startup world seems to face its own purgatory. The fears that the Silicon Valley syndrome of pushing in money on startups, and working from one valuation to a higher valuation, with little focus on actual relevance to the market, appear to be weathering the edges of startup value. Many pundits aver that these shake-ups are bound only to bring rationality into the tech industry, and retain zebra companies – those doing real business, and achieving profitability.

A good deal of VC firms has been hard hit by these hardships, with SoftBank announcing that it would be a lot more stringent in its due diligence processes before selecting investments. The company had announced a loss of over $27.7 billion on its investments for the just-ended fiscal year, in its Vision Fund. Tiger Global had also recorded its worst year since its founding, with an over 44 percent decline. The venture capital firm has lost over $16 billion in assets under management (AUM) this year, Bloomberg reports. 

Y Combinator advises startups

Y Combinator touted as the biggest global accelerator, has recently waded into the conversation on the growing clouds of foreboding on the ecosystem. The accelerator is renowned globally and has continually had its ranks of African startups increase in the recent past.

“No one can predict how bad the economy will get, but things don’t look good; the safe move is to plan for the worst,” YC says, in a message titled “Economic Downturn.” These warnings were disclosed in a letter by the accelerator to its network of startups, first reported by TechCrunch.

The accelerator goes ahead to advise:

It’s your responsibility to ensure your company will survive if you cannot raise money for the next 24 months. If your plan is to raise money in the next 6 to 12 months, you might be raising at the peak of the downturn.

In a ten-point strategy breakdown for surviving the chaos, Y Combinator details how the company should ensure it has a runway of 24 months to ensure enough funds for survival. This reflects YC’s advice to its founders to focus more on survival than topline growth. The company points out that within the last five years, most startups have experienced what is not a normal fundraising environment with valuations that are pyrrhic and unreal. The focus for companies is to avoid being, according to Jumanne Mtambalike, “vehicles created to be sold to the highest bidders in the PE and stock markets.”

Snapshot of email sent by YC to its network of founders. Source: Inc42
Snapshot of email sent by YC to its network of founders. Source: Inc42

As the letter details, startups should aim at getting to Default Alive, which denotes a startup able to achieve profitability even with the most meager of resources and money to run operations.

Sounding an even ultimate note of warning to its readers, the accelerator states further: “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.”

Africa’s opportunity: An emerging landscape

These apprehensions have been growing steadily, especially with the fall of many tech stocks. These have led investors to turn to public markets to capitulate their losses. Coupled with the rising rates of inflation, heralded by uncertainty and the lingering Russian-Ukrainian war, as well as other market forces, the situation keeps getting grimmer. For Africa, the implications of these situations on the global scene are not yet as grim, this is because Africa is yet an emerging market with just a few startups at later stages of growth. A vast majority of startups on the continent are still at the early stages, and as venture funds are now redirecting to early stage investing, Africa appears to be a good market to build rationally upwards in real valuations. In a random survey carried out on our LinkedIn and Twitter pages, a greater number of over 100+ respondents, from various industries and sectors globally, believe that African startups are rather undervalued. As the ecosystem is still young, however, it is still very early to determine how real these valuations would be. Nonetheless, Africa has a huge opportunity here, for learning.

Learning from the mistakes made in more advanced startup ecosystems, which had generally posted high and frothy valuations for many startups and funding stages, Africa can play the right cards. With the stocks of many startups collapsing heavily by over 50-70 percent within the last few months, these have brought the fault lines clearly into focus. Other devastating factors like mismanagement of funds, fraud, and deception, have further hit the global startup ecosystem, especially in the light of news like the Holmes debacle. Investors are only naturally reacting.

For Africa to lead a sustainable ecosystem, it is crucial that it pays attention to avoiding the excesses of Silicon Valley, and building upwards. Africa is not Silicon Valley. It should learn from this glaring mishap.

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