What to Do in a Market Downturn - An Internal Letter to Leonis Founders
4 Things to Consider for Startups
Given the bearish market condition and potential interests to other founders, we are sharing this internal letter that we sent out last week.
It’s a unique time to build. At Leonis, we are always here for the builders.
Best,
Jay
P.S. Feel free to forward or hit reply if you want to share your unique insights / projects with us.
Dear Leonis Founders:
By now, you’ve probably read and heard warnings and advice from Sequoia and YC about the current market condition and the upcoming “capital winter1”. It could be confusing or even intimidating.
Some of you have reached out for our perspectives on the market condition and the relevant action plan for early-stage companies. Given Sequoia and YC has thousands of companies across all stages. But most of our Leonis companies are pre-B round, so we thought to offer a more tailored perspective for our founders.
In this letter, we will talk about what a bear market means from a first-principles perspective and what a startup can do.
What is a Market Downturn
It’s tempting to think a bull market is good and a bear market is bad. But that would be too simplistic of an understanding - it would be similar to saying that “breathing in” is good and “breathing out” is bad. Both movements are important for a living breathing organism - and that’s what the market is.
At the beginning of a bull market, a few people start to get optimistic about the future; then some positive results or events would take place, which leads to more people turning from pessimistic to optimistic about the future - eventually, the whole mainstream bought in. And people start to value things and do things (i.e. borrow money, go high leverage) mostly out of fear of missing out (FOMO). And that FOMO would crunch the timeline for decision-making, the cycle of investment, and returns. It’s fast, exciting and addictive. Things appeared relatively easy.
Most of you started the company during the bull market when the capital is cheap and the valuation is lofty. Surely that was the good times.
But was it?
During such time, most startups were anxious about the round size, valuation, and the next round of financing - because that’s what everybody else was doing, from your competitors to countless inbound investors. But what was often left out of the equation is your customers - are they truly in love with your product because your products are solving real pain points of theirs, or are they merely in because you heavily subsidize the CAC or because they have extra budget to experiment on “vitamin products”?
During such time, founders were “forced” to raise lots of capital because that’s the major way to win. Uber of the world and WeWork of the world had achieved a fast scale with the constant fuel of cheap capital.
At the peak of a bull market, people don’t think, we just speculate; When space is sprinkled with lots of newly funded competitors every day, founders are typically in a reactive mode rather than proactive, because when others are spending hugely on marketing, you would need to do it too - for the defensive measure, even if you don’t want to, even if you are not ready. During this time, startup founders are mostly competing on speed, scale, and story-telling capability.
Gone are the days when the capital was cheap. And that’s a good thing, especially for early-stage founders.
At Leonis Capital, we are proud to be backing non-consensus founders like you. In each one of you, we have seen something that the majority of others have not got to see yet. You are thoughtful, resilient, and more importantly scrappy by nature. And that’s a great advantage many of your well-funded competitors and incumbents wish to have - especially in a downturn market like this2.
So what really is a market downturn? A downturn is the movement of “breathing out”. In this movement, the noise and unhealthy speculation will be squeezed out of the system. People tend to call a down market a “winter”, which suggests coldness and inactivity.
We disagree.
A down market is actually more vibrant than an up one. Under the hood, vision-driven builders will continue to build. And for once, the system is in “reset” mode that’s rewarding product-driven, customer-obsessed founders.
However, a down market could be a tricky one to navigate for most of you who are experiencing it for the first time. Here are four things we’d suggest you consider as we are going through the new climate of the capital market:
1. Agilely Survive
Much wisdom has been shared on (re)examing your cost and burn - i.e. you might not need to pull the trigger of drastic cost reduction but it’s a necessary exercise to do so that you are prepared.
The general rule of thumb is that you’d want to have at least 20 months of runway, not counting unrealized revenue. I will break down the reasoning below but if you are under 20 months (especially if you only have one year) of runway, please reach out to us now and we will strategize and figure out a viable plan for the company.
The downturn of the capital market is similar to a thunderstorm in a bio ecosystem. It pushes every stakeholder outside of the comfort zone - it’s a shake-up, it’s a reset. But it’s not necessarily a bad thing.
Like Darwin wrote in the “Origin of Species” - “It is not the strongest of the species that survives, but rather, that which is most adaptable to change.”
So when the market environment changes, our mental framework needs to change too.
The sprint just turns into a marathon. Be nimble. And Survive.
Treat every dollar as a dollar in your own checking account - treat every spend as an ROI-driven investment. In a market like this, be cautious of the non-ROI type of spending such as unproven marketing and sales spending3. It’s tempting to do so when you are anxious about getting to the PMF. However, in my 10+ years of professional experience, throwing money at acquiring users never gets a startup to PMF4 - as a matter of fact, those incumbents will have a much harder time to adjust to a new nimble environment, which is often why the best category-defining startup companies were often founded and thrive during the downtime. Oftentimes, PMF comes from something genuine, something close to your early true customers. Now the noise is gone, make yourself stand out and make them love the product.
This leads to the second point.
2. Reflect and Build
There is an old Chinese idiom called “患难见真情” which roughly translates to “adversity reveals the truth of friendships”. A down market does not call for panic, it calls for reflective calmness.
In a down market, finally you will get to see your non-core customers start to churn, the investors who don’t truly align with your long-term vision start to complain, and the team members who can take a few rough batches start to disengage. So on the surface, you may start to see slower revenue growth (esp in the B2B sector), less blind enthusiasm from investors, and reduced team morale. But those are all good things. That’s what a reset looks like.
Reset, reflect and build.
A quieter time like this calls for focus. Focus on building the product, engaging with your core early users deeply, and building real relationships with your future capital partners.
Time like this is for builders. Whichever foundation you are building - of the product, tech stack, culture, and investor relations - those fundamentals will pay off.
The bull time will come. It always does.
3. Recruit with Conviction
This point might be counter-intuitive, especially to the first point where we talk about cost-cutting. But on a deeper level, it’s consistent with the above two points. In a time like this, we would see lots of talents leaving BigCos - voluntarily or involuntarily - to join or start companies.
The talents who left their comfy jobs are the ones to pay attention to - they usually don’t behave like an executive but rather a scrappy startup founder at heart.
In a normal time, people like those might be flooded with headhunters’ cold emails and tempting signing bonuses from BigCos. However, in a down market, those competing factors are gone.
As a startup founder/ CEO, always pay good attention to great talents. Oftentimes, you won’t get to recruit them on the first try. But keep trying. Build relationships. In a down market, you are not competing on cash, you are competing on vision-fueled equity shares, which is your biggest asset. The ones who get it would stand out; the ones who don’t would never get it - it’s self-selection at work. Put the hiring posts out - actively recruit, talk to candidates, you will get to find one or two excellent missionaries during a down market - don’t waste it.
Always be recruiting, and always recruit with conviction - especially in a time like this.
4. Opportunistically Fundraise
It’s likely that we are at the beginning of a down market - and the dust is not settled yet. It might take a full quarter or two for both companies and investors to see where the new valuation benchmark is at. As nobody can time the market, we don’t yet know how long the bear market is going to last.
For that reason, if you have 20+ months of runway, you should simply focus on building - building products, building relationships, and building tractions. Then when you get to raise your head up later this year, it would be a better time to reassess the situation. If you have less than 1 year of runway, we’d need to be strategic in how and where to get additional capital before the clouds of dust get settled.
It’s important to point out that even though we might be in a down market, VC funds had a record time of fundraising over the past two years. And some of the bigger brand name funds have seen no impact in scaling their fund sizes even in a time like this. So what that means is that there is (and will continue to be) a good amount of “dry powder” sitting on the sideline that will need to be deployed over the next 2 to 3 years. And that’s good for startups.
It’s also worth noting that in a down market, investors’ mindset and framework shift more towards valuing the tangibles (product, tractions) from the previous intangibles (team background, vision). The later stage you are, the more of this shift you will start to notice.
The good news is that most of you are still counted as early stage (pre-B/C round), which is much more resilient and uncorrelated to the public market - the early stage funding and the valuation might have a slight correction but nothing dramatic unless the business fundamental goes wrong. In other words, it’s business as usual for both early-stage VCs and startups.
The *other* good news is that you get to be taking more time to socially chat with more potential stakeholders - from prospective employees to prospective capital partners. Fundamentally, you want to have partners around the table who are motivated and bought in your long-term vision (versus short-term markups & flips) - and that takes time. But in a down market, tourist investors tend to disappear and the remaining ones tend to be more long-term aligned.
You will see VCs continue to take on meetings - some of them will be more engaged than ever because they truly care about your business and some of them will be less engaged now because they don’t have the mental core for your sector and now lose conviction due to the swing of public market performance, and some of them are simply just taking long vacations. I say forget about the latter two groups of VCs but do set aside time for the select former ones.
Don’t think of fundraising as a task; instead, think of it as an education & recruiting process with your future capital partner - investment is a by product, and it always come with a good truth-finding process.
It’s important to stress again that neither a bull market nor a bear market lasts forever - although human psychology tends to make us believe that it does, particularly when we are living through it.
Bull and bear are both healthy movements of the market: without the bull, value creation will never get to be recognized and appreciated; without the bear, the noise will never rescind and we don’t get the chance to focus on long-term fundamentals.
It’s time to build.
Best,
Jay and the Leonis Capital Team
P.S. As always, we are only a call/ text away.
Earlier this week it was reported that S&P officially entered into a bear market.
Many of them will continue to struggle with reducing the burn, letting alone having the energy to find the next innovation.
It’s a chain effect, we will start to see spending cut rippling throughout the economy - first it’s corporate “innovation budget”, then marketing and payroll.
If capital is the issue here, BigCos would have no problem finding the next innovation PMF.