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🦄 vol. 42
karl chats about the economic downturn and its effect on venture capital 🥶
vc winter 🥶
We’re down bad 🤕. In a number of countries, we’ve officially entered into a recession (when an economy has experienced negative GDP growth for 2 successive quarters). If we’re honest, it’s not really surprising considering we just fought through the most significant economic situation since the Great Financial Crisis (GFC) in 2008. Globally, the Financial Times predicts that we’ll enter into recession by early 2023, given the fact that the US is experiencing its highest inflation in 40 years.
What brought us here? 👀
Top down, the macroeconomic situation is similar to what we’ve seen time and time again, as Ray Dalio points out in his book ‘Principles for Dealing with the Changing World Order’ (YouTube summary 🤗). However, when things looked like this in the past, we had a lot more ammunition in the coffers to support our recovery. Now, we sit in a situation where that’s largely been exhausted already. Governments and reserve banks went all out during the pandemic to stimulate the global economy, getting us our prized ‘V’ shape recovery. But just as things were looking hopeful… we were ‘Put-in’ a terrible situation. To be fair, his antics just further exacerbated an already tricky situation with a flimsy foundation.
Extreme fiscal and monetary measures in the form of reduced interest rates and quantitative easing (QE) pumped the market with money (making it extremely cheap to come by). Not to mention the additional stimulus checks. For startups, this meant ‘free money’, as interest rates effectively made it easier to obtain funding.
Inflated cash balances and the increased risk appetite meant that demand began to outstrip supply and cracks in supply chains started to show. Inflationary pressures became even more apparent as the Ukrainian war materialised. Supply chain constraints and commodity price spikes, namely oil, sent inflation to the highest levels in decades.
Public equity markets 📈
With the additional money, markets and equities flourished, specifically those related to remote work and e-commerce. Unfortunately, these gains were all absorbed as quickly as they came. The Nasdaq, the index for the top 100 tech companies in the US, is now down 34% since its November highs of last year.
VC outlook? 👓
In the US, the quarter-over-quarter (QoQ) funding growth that we’ve become accustomed to finally showed signs of slowing down. Both the number of deals and aggregate funding amount decreased, in line with the macro economic sentiment. Negative growth is likely to continue given the continued depressed market climate and publicly stated pull-back from major cross-over funds (e.g. SoftBank & Tiger Global) playing in the $100 million market and unicorn hunting ahead of their IPOs 🦄.
To contrast this, Africa can’t seem to stop growing! Currently, we sit on a 7-month streak where the year-over-year (YoY) funding has been higher than that of the same month in the year prior. Note that the decrease in month-over-month (MoM) funding in April and May is a show of cyclicality, Q2 is typically a quiet quarter in Africa.
As with all things, is Africa late to the party here? Will we start to feel the slowdown in the coming months and will the valuation crunch affect us? Likely 🤷🏽♂️.
International investors have largely shifted their money out of risky asset classes globally as equities and alternative’s growth potential no longer offer returns matching the increased risk. However, this may not be true for the African ecosystem. That being said, the same macro economic challenges are prevalent in Africa. Perhaps South Africa’s advanced financial system with close alignment to global markets has played a role in the 30% reduction in startup funding raised in SA between January-May compared to the same period last year. This, compared to the 154% growth in Nigeria, 212% in Egypt and 436% in Kenya.
Regardless, startup multiple driven valuation models are generally driven by listed markets and so the burn will inevitably trickle in there. It’s also likely that the time between funding rounds increases while the size of the deals begin to reduce as the pull-back in $100 million rounds hits Africa too.
Navigating tips for startups? 🧭
VC powerhouses, Y-Combinator and Sequoia, were prompt in releasing notes to their founders - offering words of wisdom as well as stories demystifying the past to guide them through the storm ahead. According to Sequoia, “it is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.” Startups that succeed will focus on:
Business fundamentals 🔑
Reset, go back to basics. Get your unit economics above water.
Deepen your relationships and earnings from customers. Ensure product market fit.
Being adaptable 🔀
The environment has changed and will continue to change.
Pro-act where you can, react fast where you have to.
Taking opportunities ➕
Funding - if it presents itself, and runway is constrained - bite the bullet on terms. Survival > Poor terms.
Acquiring - if you have a war-chest, sufficient runway and the opportunity is good not just cheap; take advantage of the weak competition and increase your market share.
Hiring - top talent will be available, considering hiring freezes and liquidations. Choose wisely after consolidating and trimming fat.
Planning for the worst 🚨
Extend runway as much as possible, target 24 months.
Cut nonessential costs; growth projects, employees, subscriptions etc.
What next? 🔮
‘Vibes and inshallah’ were dominant factors in term sheets and due diligence during our recent ±12 year bull run. The reckoning is here and with that brings an increased level of scrutiny moving forward. Survival of the fittest, will be the theme for the next few quarters - who can stretch their runway the longest and who can set themselves up for success in the coming years.
Only time will tell how long this lasts, but seeing as our startup ecosystem has yet to truly feel it, we’d better buckle up.
sash was shook to learn that disney+ could lose up to 20 million subscribers after losing the streaming rights to the indian premier league
karl enjoyed this video, from y-combinator, on how to survive an economic downturn