Our startup ecosystem, like all markets, goes through regular ups and downs. Sometimes we go through a period of unusually high highs, like the back half of 2020 and most of 2021. Sometimes we go through periods of unusually low lows, like the aftermath of the Great Recession post 2008. Now, we’re in the unwinding period of the most recent Great Exuberance and it’ll be painful as we work through the necessary changes.
Only, I don’t believe we’re headed for a long winter. We have too many positive characteristics in our favor. Let’s look at a few:
Depth of Business Model Understanding
Metrics, best practices, and playbooks on how to build SaaS, cloud, and marketplaces abound. We have numerous examples of startups that have scaled past $100M in revenue and a growing number that have scaled past $1B in revenue. While we’re still advancing our understanding of the business model, it’s clear we’re in a good spot with decades of foundational work.
Base of Existing Revenue
While some startups were raising money at astronomical revenue multiples, the vast majority raised at normal-to-high revenue multiples, and therefore have a strong base of revenue. Because these are high margin, capital efficient businesses, almost all revenue goes towards employee salaries plus sales and marketing expenses. If funding were to completely dry up, these startups could dramatically cut costs (layoff employees) and become profitable (cash flow positive) almost immediately. Once profitable, the startup is no longer on the fundraising treadmill and is default alive. While growth is likely to slow, it’s better than the alternative.
Capital to Be Deployed
With a quarter trillion dollars raised to invest in private companies recently (mostly in private equity with a meaningful percentage in venture capital), there’s a tremendous amount of money on the sidelines that has to be put to work. Why? Investors must justify their management fees and therefore need to do deals. Limited partners have a challenge in that they’ve signed contracts to supply capital to these investors, but because of allocation percentages to different types of assets, they’re overweight in venture / alternative assets (denominator effect). Being overweight, these limited partners will often ask that the capital allocator slow down their deployment cycles and minimize capital calls until things are more balanced. While this will slow funding, there’s still an abundance that is going to be invested in startups, especially the ones that have the best metrics and opportunities.
The startup ecosystem is going through a normal course correction and will emerge healthy and strong. Startups that were on shaky ground will get washed out and startups that have the highest potential will get more capital and talent. Much like a forest fire cleaning out underbrush and providing nutrients for the soil, so too does this creative destruction make for a stronger ecosystem going forward.