Founders have to cut spending without giving up on dreaming big

VP managers are holding tough conversations with entrepreneurs about navigating a rockier economic landscape while still trying to play cheerleader.

As mounting signs of lower valuations and louder talk of an imminent recession make fundraising more difficult, entrepreneurs are being asked to keep two opposing ideas top of mind at once: how to tighten their belts and continue dreaming big about what many fund managers see as unprecedented market opportunities.

When Sequoia Capital released a slide deck that accompanied a Zoom call it held with founders of its portfolio companies in mid-May, it alerted the VC industry “about fundamental things in our world that have shifted,” Liza Landsman, GP at New Enterprise Associates, said on a panel at the NYC Summit held last week.

The thrust of Sequoia’s presentation was to urge founders to be ready to cut spending in order to extend their runway with capital they had already amassed until the market downturn has run its course.

Citing the Fed’s exhaustion of monetary and fiscal policy tools during the pandemic and warning that sustained inflation and geopolitical conflicts would further limit the ability for a quick-fix policy solution, Sequoia said it expected the market downturn to impact consumer behavior, labor markets, supply chains and more. Sequoia said it was “not a time to panic [but] a time to pause and reassess,” but added that it expected a longer recovery.

“If you’re not having those conversations with founders, you’re not doing a service to your LPs,” Landsman said during a discussion with other VC managers about macroeconomic headwinds affecting start-ups.

Landsman spoke about how to “navigate the scarce capital environment” by doing things that “separate great companies from good companies,” including using capital to increase market share or execute small tuck-in acquisitions that are accretive steps that create long-term sustainability. She added that founders need to carefully consider what they invest in given inflation.

Harley Miller, founder and managing partner of Brooklyn-based Left Lane Capital, said he expects to see a lot of companies make their products worse in order to conserve capital, which will hurt their prospects for continuing to attract capital in the future.

At the same time, fund managers recognize that they can’t afford to abandon their cheerleading stance and risk weakening their founders’ vision and moxie.

“You have to ask yourself whether you have the ability to dream big,” Marcelo Claure, who stepped down as chief operating officer at SoftBank earlier this year, said during a separate session. Arguing that for the first time in history all areas of business are being transformed by the application of technology to address a range of issues, Claure said, “this is a great time to be an entrepreneur.”

He cited the resistance he encountered several years ago as the new CEO of Sprint, which was losing $5 billion a year when he proposed a merger with T-Mobile. “If you don’t dream big, you’ll never be able to take your company to the level it deserves to go to,” Claure said.

During another session, former US Treasury secretary Robert Rubin said he expects core inflation to remain around 5 percent between now and the middle of 2023, when it is likely to start coming down toward 4 percent. Among the factors that will likely keep inflation intact are uncertainty around energy prices and serious drought-related issues in China that could affect global supply chains, Rubin said.

And because the Federal Reserve has been behind the curve and needs to “be very aggressive” to control inflation, the US is likely to be in a recession next year, Rubin said.

Claure, who recently launched his own VC firm, Claure Capital, was more sanguine about inflation. Because of how aggressive the Fed has been in raising interest rates, it will be only six to nine months before inflation starts to moderate, he predicted. “But access to cheap capital won’t come back” any time soon, he added.

Claure is hopeful that experiencing the current economic downturn will ultimately be a valuable lesson for investors that will make them better able to judge companies’ prospects for profitability.

Companies that grow without a pathway to profitability will be in trouble when they try to raise more capital, he said.

“Companies still expect to face wage pressure and less pricing power,” Rubin said. His advice for tech companies on navigating the next 24 months is to focus on the long term with a cautionary bias.

Rubin agreed there are enormous opportunities in tech but said companies have to make sure not to go broke in the short term, and thus, be unable to take advantage of them. He cautioned founders to not take on debt that they aren’t able to manage.

Despite the optimistic bias, VC managers should be prepared to advise founders on when it’s time to recognize their own limited growth prospects and consolidate with better positioned peers.

“Good companies will remain set on their growth drivers,“ said Alex Woodgate, head of business development for JP Morgan’s venture arm, Capital Connect. “What we’re working on now is what percentage of companies we’ve funded have stopped [growing and need to consider consolidation].”