How start-up founders can fund and power growth during a tough fundraising environment.
This article was created in partnership with the Capchase team.
This year, inflation-driven interest rate hikes, as well as global economic and political issues, have caused the third largest downturn of NASDAQ in the past two decades.
A consequence of this downturn is the layoffs taking place at tech companies of all sizes in almost every industry. Social media, and LinkedIn in particular, have made reductions in headcounts which is a very visible indicator of SaaS companies reining in their spending to lengthen runways.
Public software company valuation multiples have shrunk by 60% on average and more than 80% in some cases. That realignment is now hitting privately funded companies. Funding that was previously meant to last 18 months needs to last for 36.
It is entirely understandable that in this environment, companies resort to reducing payroll, especially in sales and marketing teams, as a way to cut costs. Venture-backed startups are doing what they can to avoid raising cash in a down round.
But, although these are choppy times for founders, with investors demanding more discipline from VCs and business health now the most important metric, growth is still an option. Indeed, it might be the best option of all.
The emergence of the world's largest companies during past downturns is often remarked upon. It has become a cliche to say that there is opportunity in a crisis. But, when startups consider alternate forms of funding available to them beyond traditional venture capital, as well as the ease of hiring contractors off the payroll and across borders today, there are suddenly a wealth of opportunities to fund and power growth through and beyond this downturn.
Layoffs are just one way of cutting CAC - and not always the most effective
The first team members to be let go often work in functions such as communications, sales, and customer service. But making these layoffs to cut costs can lead to a spiral of decline. The customer experience and the ability of a startup to grow is affected. Customer acquisition can become less targeted. Team morale is reduced, as others have to take on the extra work. The promising startup employees joined is now facing an uncertain future.
However, there is currently an opportunity for startups who focus on their individual circumstances and block out the clamor of the wider market. Those that choose to grow now can win a disproportionate market share cheaply and efficiently.
As their competitors pull back, the entire customer base is there for the taking. Not only that, but by maintaining staff, startups are ready to rebound at full speed when demand returns - perhaps with the best talent in the industry now among their staff.
If, as some predict, the recession affects only the most overvalued sectors of the tech industry, startups that quickly cut headcount to lower customer acquisition costs (CAC) might find it difficult and more expensive to hire talent later. In some cases, their former team members may have set up their own businesses that are new direct competitors.
Other ways to lower CAC in the downturn
CAC can be lowered by reducing headcount - but it can also be lowered by increasing efficiency and targeting. While the former reduces costs, the latter increases customers - a more desirable outcome.
Some ways of doing this include:
- Segmenting customers - grouping customers with similar attributes so they can be targeted effectively
- Identity marketing - offering discounts that reflect the identity of customers
- Optimizing the website and online identity - so potential customers can understand what your startup does quickly, and existing customers can see you are on top of industry developments
- Researching consumer recession behaviors - in a downturn, customers will need more convincing to buy your product. But if you can convince them it will save them money, they will be more inclined to buy
All of these tactics are done best by communications, sales, and customer service experts.
But to pay these salaries, some companies need funding. Right now, VCs are reserving capital for their best-performing and established investments, leading to fewer opportunities for early-stage companies.
They are also paying a lot more attention to unit economics, growth, and capital efficiency of the business. It’s no longer about growth at all costs.
Because of the supply and demand of capital - things are shifting. There are more founders looking to raise capital than VCs looking to deploy it. As a result, valuations have come down, which can mean more dilution and a drop in the value of your investors, employees, and founders’ equity in the business.
As a result, some founders are choosing not to raise at this time. They are finding alternative ways to extend runway and continue to invest in growth. Especially because if you want to sustain your last valuation, you now need to reach higher milestones - so it’s not a moment to pause your investment in growth.
So what do you do?
The alternative: revenue-based financing
The alternative finance market is booming. Its value is set to grow by $76.15 billion, progressing at a CAGR of 10% from 2020 to 2025, according to Technavio.
Revenue-based financing can be a great option to extend runway and access the funds needed to continue to invest in growth. It is an especially good fit for companies with recurring revenue, like SaaS startups.
How does it work?
A lender, usually an investor or financing firm, provides capital in return for payments based on a startup’s annual recurring revenue (ARR). Businesses can access non-dilutive financing at an earlier stage than has traditionally been possible with bank loans.
Usefully during this downturn, you can invest this extra capital in streamlined customer acquisition that generates quick payback, leading to supercharged growth. Funds that were previously locked up in go-to-market can be diverted into research and development, general and administrative expenses, and more, unlocking new business opportunities.
Startups can drive growth with zero cash flow impact, scaling CAC spend without worrying about cash flow limitations, even during the downturn. They can continue to maintain or even expand sales and marketing teams, giving them an edge over competitors.
Another way VC-backed start-ups can use revenue-based financing as part of a smart growth strategy is to use the alternative financing to cover day-to-day costs: as working capital. This means they are able to earmark their expensive VC capital for longer-term investments. For example: Nowports, a provider of global freight solutions, expanded their global footprint and opened offices in the key markets of Mexico, Chile, Colombia, Peru, and now Brazil, because they raised revenue-based financing from Capchase to cover their day-to-day costs. “This way, our equity round money is strictly spent on growing the company: new operations, overseas expansion, and maintaining the cost of HQ,” said Diego Coria, Nowports’ Global Finance Manager.
What this unlocks: global expansion for growth in a downturn
Some founders only think about global expansion as a move for times when the economic environment is peaceful. When thinking about tightening their belts and being mindful of their resources, global expansion might be one of the things they consider cutting. Far from expanding, they may think that cutting their operation - especially headcount - is the only way forward.
However, this response can be counterproductive and ill thought through, damaging the startup’s ability to be prepared for the bounceback.
Founders shouldn’t feel pressured to cut the size of their team - or of their growth ambitions. Making layoffs to protect the bottom line, and curtailing moves into markets with clear demand, can actually become a self fulfilling prophecy. Regarding workforce cuts: the first team members that are let go are often in functions such as communications, sales, and customer service. Inevitably this impacts the customer experience and the ability of a startup to continue to grow. Likewise, foregoing existing plans to expand into new markets can put start-ups on the back foot when it comes to taking advantage of any post-recession boom. If despite the recession, you can expand your operations into a key market, you will have the advantage over your competitors by already being in place when the economic conditions start to improve.
That is why it is paramount that founders block out the noise from the wider market. Instead, focus entirely on your own startup’s circumstances. This will be the key to managing this downturn. Founders should use this period as an opportunity. Recessions tend to offer opportunities to well-run businesses. Whether that’s by acquiring the customer base of struggling competitors, building a strong base in a new market or preparing your startup to scale rapidly when demand rebounds.
Of course, keep managing your runway diligently. Have a look at your operations, where can they be streamlined? You may well find that, in fact, some of your expansion plans could actually help you streamline your operations. How? Consider the benefits of being able to hire the most talented level of people in geographies with a lower cost of living: you could increase the effectiveness of your workforce while significantly reducing its cost. Now that hybrid and remote working are embedded in effective working culture, the benefits of a global workforce are within reach for any startup.
The necessary legal and administrative work to achieve this cost-efficient global hiring can, it’s true, be complicated. In the past, this was a major hurdle. But now services exist that streamline this process: global payroll providers help startups to grow efficiently by managing hiring and workforce administration in new regions.
With revenue-based finance to cover your Customer Acquisition Costs - including the cost of your sales and marketing teams - you have the funding for these global hires. And with a global payroll provider like Deel, you have the means to use this funding to drive your growth with minimum time and effort drain on your existing team. The result can be a higher level of expertise on your team, at a fraction of the cost, for cost-efficient growth despite the downturn.
Times are hard for startups right now. But growth and expansion are still possible. The thriving alternative finance industry and the newfound ease of hiring across borders is making it possible for well-run startups to continue to secure capital to protect their business and continue to thrive.