As an institutional VC for over a decade and a startup guy before that, I’ve learned a few hard lessons about building companies across economic cycles. Churchill once said, “Never waste a good crisis,” and for startups, a recession is a great time to build.

Necessity is the mother of invention

When I graduated from university in 2003, the US had yet to emerge from the tech winter which followed the dot.com boom and bust. I distinctly recall interning in the tech M&A group of a Silicon Valley investment bank where I came to work one day to learn that all of my colleagues in the private equity team had been dismissed.

We all thought the world was coming to an end. And yet, while many unsustainable Web1 e-comm companies like WebVan and Pets.com went bust, emerging platforms like Google developed defensible technology (e.g. search algorithms) to create business models that could scale profitably, raising substantial funding in a challenging climate.

Many years later, as I graduated from business school in 2010, the world was again reeling from the Great Recession. I spent half my MBA summer interning with a private equity fund where we were buying and levering up sunset assets like newspapers at deep value discounts, and the other half at Microsoft Xbox where cloud gaming was beginning to upend traditional boxed software.

My colleagues and I all wondered when the economy was going to turn back to growth. And yet, while some over-leveraged financial institutions like Lehman Brothers shut their doors, new cloud-based Web2 platforms emerged in digital payments, social media and content delivery to generate tremendous value, startups like Facebook and games-as-a-service pioneer Zynga, which I joined as a PM, staying through their IPO.

Expect the best, prepare for the worst

There is no question that we are now in another tech winter. The Nasdaq lost 25 per cent in YTD June 2022 before bouncing back slightly, and multiples are predicted to compress another 25-30 per cent, suggesting valuations will come down further.

Also Read: How to survive a recession and thrive afterward

Moreover, high inflation is disincentivising savings and investment. Federal funds reached 2.25 per cent in July and is expected to hit three per cent by the end of year, leading to the highest borrowing costs since 2019. Technical recession is two quarters of negative growth, and on a macro basis we are absolutely in the thick of it.

However, startups are all about micro execution bucking macro trends. In addition to the examples above like Google, Facebook and Zynga; here in Asia, Alibaba and Taobao were forged in the midst of the Asian Financial Crisis while Grab and Uber were both founded during the Great Recession.

In the Southeast Asia of 2022, we have the benefit of a young, regional population, rising middle class purchasing power and strong and growing employment (as does the US which despite everything, just added 528,000 jobs in July).

Certainly, many fledging SEA companies will fail, but startups with strong leadership and a path to profitability have the potential to thrive. Some may even gobble up their competitors, establish market leadership, disrupt incumbents and accelerate the transformation of the industries in which they compete.

Three tips on how to build stronger in this recession

I expect that founders and management teams that do the following will be best placed to succeed:

Use inflation to maximum advantage

Where possible, increase pricing. For services businesses, wage inflation tends to trail consumer price increases, so inflation can increase short term margins. Where price hikes are not possible, lock customers into longer tenure contracts at prevailing pricing, and use that demand visibility to manage costs by batching or building inventory ahead of input price hikes.

Also Read: How small companies can prepare for recession

I recently spoke to a resourceful entrepreneur in the Indonesian food sector who shared that as his input prices such as seed costs increased, he shifted product mix toward lower cost and lower quality vegetables, and in doing so defended margin without passing price hikes on, enabling him to take share. These are the teams who know what it takes to succeed in tough environments.

Obsess about the balance sheet and statement of cash flows

In good times, most startups tend to focus on the top half of the P&L, specifically GMV and revenue. In tough times, cash is the only king. Financially savvy operators keep a tight rein on unit economics and the cash flow cycles of their businesses.

Cash management entails delaying payables and collecting receivables aggressively, even if it means causing friction with vendors or customers unaccustomed to tougher terms, or giving away some margin to factoring costs. Tight control makes for longevity.

Capitalise creatively

Companies that don’t follow the fairy tale of successive up rounds can often be shunned as failures rather than lauded as survivors. Savvy founders know to identify and avoid these external and internal biases, starting with openly acknowledging that raising at a flat or down round is a sign of maturity and adaptability and by finding VCs who share the same mindset.

I’ve heard some SEA VCs express they would rather make a new, small “club” bet on a seed team going after the same challenged business model than do the hard work of recapitalising a struggling or pivoting Series B startup that has fallen out of favour. Until you’re profitable, runway is crucial to survival, and you want VCs who are fighters, not cheerleaders, in your corner.

When the macro is correcting 25-30 per cent down, down rounds and recaps are necessary parts of fortifying the capital base; rather than fight it, partner with an experienced institutional VC willing to do the cap table surgery work, even if it means restructuring, giving up more dilution at a lower valuation or potentially causing friction with earlier investors unaccustomed to having their shareholdings substantially diminished.

Seize the moment

At the end of the day, opportunity is greatest during times of volatility. As Darwin said, “It is not the strongest of the species that survives, nor the most intelligent; it is the one most adaptable to change.”

For those with that attitude, this is a great time to build. At Altara Ventures we look forward to building Southeast Asian startups with resourceful founders who like getting creative as they face the challenges and opportunities ahead.

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