Home » Y-Combinator (YC) Letter to Founders Warns of Economic Downturn 2022

Y-Combinator (YC) Letter to Founders Warns of Economic Downturn 2022

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Y-Combinator, one of the top VCs in the world, recently sent an email to all its founders warning that “Things don’t look good.”

Public companies are going through layoffs, private companies are tightening their bootstraps, and VC investors are withholding their checks.

With inflation as high as it is and the Fed willing to do whatever it takes to bring it down, even at the expense of hammering stock and asset prices down, the macro landscape has never been more uncertain.

It is likely the US is already in the beginning stages of a recession as of May 2022. The data may not show it yet, but data is backwards looking and evidence growth is slowing is starting to show.

While startup fundraising reached record highs in 2021, the sudden shift in the macro environment has caused investors to do a complete 180 this year.

Startups that previously raised a round in 2020 or 2021 now have the difficulty of raising future rounds at a higher valuation than before. Raising at a downround, or a lower valuation, implies weakness in the company and also hurts any existing investors.

As such, YC is advising its founders to cut costs and plan for the worst in order to weather this coming recession. As growth slows, funding is likely to slow down even further. Earlier startups that have yet to find product-market fit or aren’t “Default Alive” will have the hardest time. Default alive is a term coined by YC founder Paul Graham, which means if a business can remain profitable with its existing capital at a constant growth rate and current expenses.

Other startups that are likely to have a hard time are international companies and those that are asset heavy, low margin, and have a high burn rate.

The silver lining is that those companies that manage to survive the downturn are favorably positioned. They can take market share from companies who didn’t fare as well. The lessons learned from surviving are also highly beneficial to take away.

Here’s the letter in full below:

The full YC letter transcript can also be read below.

Greetings YC Founders,

During this week we’ve done office hours with a large number of YC companies. They reached out to ask whether they should change their plans around spending, runway, hiring, and funding rounds based on the current state of public markets. What we’ve told them is that economic downturns often become huge opportunities for the founders who quickly change their mindset, plan ahead, and make sure their company survives.

Here are some thoughts to consider when making your plans:

  1. No one can predict how bad the economy will get, but things don’t look good.
  2. The safe move is to plan for the worst. If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days. Your goal should be to get to Default Alive.
  3. If you don’t have the runway to reach default alive and your existing investors or new investors are willing to give you more money right now (even on the same terms as your last round) you should strongly consider taking it.
  4. Regardless of your ability to fundraise, it’s your responsibility to ensure your company will survive if you cannot raise money for the next 24 months.
  5. Understand that the poor public market performance of tech companies significantly impacts VC investing. VCs will have a much harder time raising money and their LPs will expect more investment discipline. As a result, during economic downturns even the top tier VC funds with a lot of money slow down their deployment of capital (lesser funds often stop investing or die). This causes less competition between funds for deals which results in lower valuations, lower round sizes, and many fewer deals completed. In these situations, investors also reserve more capital to backstop their best performing companies, which further reduces the number of new financings. This slow down will have a disproportionate impact on international companies, asset heavy companies, low margin companies, hardtech, and other companies with high burn and long time to revenue. Note that the numbers of meetings investors take don’t decrease in proportion to the reduction in total investment. It’s easy to be fooled into thinking a fund is actively investing when it is not.
  6. For those of you who have started your company within the last 5 years, question what you believe to be the normal fundraising environment. Your fundraising experience was most likely not normal and future fundraises will be much more difficult.
  7. If you are post Series A and pre-product market fit, don’t expect another round to happen at all until you have obviously hit product market fit. If you are pre-series A, the Series A Milestones we publish here might even turn out to be a bit too low.
  8. If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan.
  9. Remember that many of your competitors will not plan well, maintain high burn, and only figure out they are screwed when they try to raise their next round. You can often pick up significant market share in an economic downturn by just staying alive.
  10.   For more thoughts watch this video we’ve created: Save Your Startup during an Economic Downturn

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