The benefit of a slump.

The boom years of the last decade are unmistakably finished.

The significant decline in sales multiples for technology companies exemplifies the magnitude of the present crisis better than any other indicator. Consider the rise and fall of AMZN during the dot-comm bubble with SHOP in the previous year. AMZN fell from 55x trailing revenues to 1x, while the latter is currently in free slide from 71x to 7x – an all-time low:

These strangely similar graphs remind us of previous corrections, specifically the 2008-2009 financial crisis, the dot-com bubble implosion of 2000-2002, and the 1987 Black Monday catastrophe. The current crisis shares some characteristics with earlier corrections (e.g., speculative asset bubbles, Fed rate hikes), but others are distinct (e.g. post-COVID headwinds, war in Ukraine, supply chain disruptions, ETF outflows). Each of these periods saw extended and extreme valuation declines, which culled the herd of startups and forced huge reforms across the IT industry.

Stay optimistic.

In cases like this, the public narrative quickly and violently goes negative. It’s paralyzing to see your stock portfolio plummet by 3-5% week after week. Schadenfreude has set in for corporations that raised funds at exorbitant valuations and then carelessly spent it all as the market crashed.

Many ostensibly “founder-friendly” investors, who have only ever witnessed a bull market, are now having their first truly unpleasant meetings with CEOs. Fast-moving, late-stage pools of capital, ostensibly on a mission to “disrupt” venture capital just a few years ago, are suddenly seeing the value of their positions decline by 40-50% in less than a year, wiping out decades of compounding returns.

Notwithstanding the obvious market turmoil, our inclination at Lightspeed is toward positivity. Technology progress continues unabated during all market cycles. Business workflows will be digital in greater numbers. Cloud computing will become more prevalent in enterprise infrastructure. Globally, more consumers and small and medium-sized businesses (SMBs) will go online. Web3, AR/VR, AI/automation, and other technologies are all in their early stages.

To be clear, the journey ahead will be difficult. Many CEOs will make difficult decisions in order to keep their businesses afloat in turbulent circumstances. Some will be forced to make tradeoffs that appeared absurd or unneeded only a few months ago. When difficult judgments must be made, we see a silver lining.

Don’t let a good crisis go to waste.

History has shown that CEOs who act decisively now and make key changes to their businesses will be in a stronger position when markets return to normalcy. We understand that some decisions may be unfamiliar or difficult. As a result, we’ve gathered a few examples of how companies in our portfolio have improved their operations throughout previous crises.

Revise your assumptions on talent.

Acquiring and maintaining talent has been extremely difficult in recent years. Companies threw greater and more tempting packages to candidates as valuations rose, creating a competitive flywheel that made it difficult for smaller, less well-known enterprises to compete. Employee retention became difficult as employees realized they might hit their 1-year cliffs and move on to a different business with a higher water mark in remuneration.

Overall, our portfolio’s personnel expenses swole quickly to meet this new normal, and CEOs ignored it as long as they could raise additional capital at inflated prices to fuel the talent war.

Cut non-essential activities.

Businesses with plenty of cash have an infinite number of ways to spend it. While the primary business is functioning well and cash is cheap, all of these ideas, whether trying new marketing channels, hiring new engineers to construct a product extension, or entering a new geography, appear to be sound. If management’s bandwidth is the limited resource, all of these new activities need that its attention be divided. Early stage companies with enough entrepreneurial leaders to execute on many objectives at once are rare.

During a downturn, it is necessary to cut these non-essential tasks. We advise CEOs to think deeply about what their company’s core “need to believe” is. While prioritizing various activities, we recommend you to consider along numerous orthogonal axes, such as the ones listed below, and to create a specific framework for your business:

  • To what extent does this initiative move your north star metric?
  • What is its degree of difficulty?
  • What is the size of the potential payoff and what is the requisite investment level? Over what time horizon?
  • Is the opportunity perishable or non-perishable?
  • Do you have the capabilities in house, or does it require a new competency to be built?
  • Do we understand how to model its success or failure, and what are the input metrics we should track?

Hone your business model.

In normal markets, CEOs frequently “exchange profitability for expansion.” Lowering pricing, particularly in consumer commerce enterprises where commodities have significant demand elasticity, can boost growth. Before planned expansion, enterprise organizations would frequently invest in sales, marketing, and support. Since money is focused on growth above all else, entrepreneurs frequently “kick the can down the road” on profitability by experimenting with pricing, discounts, and other economic tactics.

The disadvantage of this method is that it postpones the identification of a business model. Finally, it’s difficult to underwrite growth without a firm grasp on a company’s unit economic formula, its drivers, and how to enhance them over time. As a matter of survival in a capital-constrained economy, businesses must focus on the input parameters of strong unit economics. Investors simply will not underwrite later-stage startups in these areas that have not completed this important task.

Consolidate your lead.

In low-capital circumstances, there is a lot of FOMO about winning in a market. That implies businesses will outspend, out-discount, and out-maneuver one another in order to get users. Companies incur several types of operational debt when they grow too quickly and compete on too many fronts. In these types of circumstances, every struggle appears to be existential.

When the market cools, everyone retrenchments. They determine what is strategic and what may be abandoned. It is typically in these situations that astute players (often the most dominating ones) can begin to consolidate a market that would otherwise be overly competitive. When competitors are cash-strapped and no one wants to fight it out, M&A is much easier.

Survive before you thrive.

The most shocking mentality shift that CEOs have had to face in recent years is that they can no longer rely on greater money to cover up difficulties. The funds may indeed materialize, but we do not advocate planning on them for 2022 or even 2023.

While growth may stall in the short term, future investors will not hold it against you if you temporarily scale back your objectives to shore up the business. Companies who use this time to reinforce their fundamentals will be rewarded in the long run by their customers and the financial markets.

Moreover, keep in mind that some of the most valuable companies of the last generation (for example, ABNB, NET, SNAP*, UBER) were founded in the years following the 2008 financial crisis. For some of these businesses, the journey was long and difficult, but the downturn ultimately proved to be a formative crucible.