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A downturn is the perfect time to start a startup

A downturn is the perfect time to start a startup

Ravi Parikh
Co-founder & CEO
May 23, 2022
4 min read

Tech is going through a steep market correction right now. Companies are doing layoffs. Y Combinator published a letter to their founders telling them how to prepare for tough times ahead.

Counterintuitively, this is a great time to start a new company–even better than in 2021 when tech was red-hot. I have friends who were considering starting a company this year, but are now feeling a bit skittish. This is the exact opposite of how you should be feeling right now.

To be clear–this is not a great time for growth-stage startups or big tech companies. But for early stage, pre-product market fit startups, there are several structural reasons why companies founded today are setup for success. I'll explain why below.

Seed and pre-seed capital is still abundant

Last year was the easiest time in history to raise startup capital for basically any stage. Rounds from pre-seed to IPO were getting done at record-breaking speed and valuations. However, public market tech valuations have collapsed, and this has cascaded down to VC rounds. There are tons of overvalued companies that are finding it basically impossible to raise right now.

However, seed rounds are an exception. Seed rounds are still getting done at a high rate. It's something of a perfect storm for seed fundraising: tons of investors raised massive funds over the last couple years. They're unable to deploy that capital responsibly at later stages, but they still have to put that money somewhere. Seed-stage companies are one of the only places you can put money right now and still expect a good return.

Raising money is not easy, and there are several problems in how capital gets allocated. But for seed rounds in 2022, it's not much harder than it was before.

You'll get higher-quality customer feedback

Startups have to make stuff that people want. This is harder to do when money is abundant than when it's scarce. Let's say you're selling a SaaS product: in a world where every startup has tons of cash, they can buy stuff just to try it out without worrying too much whether that product solves a real need. Or, you might have customers who are continuing to pay every month on a credit card despite not using it, and the company they're at has sloppy financial controls and forgets to cancel.

In a downturn, you can't get away with that. Companies scrutinize spend and cut anything that isn't clearly valuable. You have to build something with real ROI to get companies to use their limited budgets on your product. This constraint will force you to iterate and build a better product–you won't be able to fool yourself into thinking you have product-market fit when you don't.

We launched Airplane last year and started charging for the product in September 2021. Since then, we've had strong paid customer growth and close to zero churn. I'd like to think this is the sign of a great product, but if I'm being honest, there are probably a few customers for whom we're a "nice-to-have." It’s very possible that our churn rate will increase in the next few months. While I of course don't want that to happen, I welcome the opportunity to get meaningful feedback and force ourselves to make the product even better.

Overall, the customer feedback, buying decisions, and churn rates you see in your product are much more instructive than they were last year. If you're an early stage company, this is exactly what you want.

You were going to experience a downturn at some point. Doing so early sets you up for success

There are plenty of tech startups that were founded in 2011-18 that have operated for their entire existence in a bull market. These are 1,000+ person companies that have never been through a downturn. At that size, there is a massive amount of inertia around your operating model and the fundamental assumptions of your business. These companies' assumptions around customer acquisition costs, capital efficiency, fundraising prospects, etc were all formed in a very different environment than today. These companies will all need to course-correct quickly.

By contrast, your 2 person startup has none of those issues. You can operate identically to how you would have last year: build cool stuff and talk to customers.

Most importantly, startups founded today will be forged during a time when they'll learn to be scrappy and capital efficient. It’s much easier to start efficiently and increase spend later than to spend a lot from day one and scramble to figure out how to cut costs later on.

The opportunity cost is lower than it was last year

Starting a startup is tough. You end up taking a below-market or zero salary and work hard for something that's most likely not going to work. This is just as true today as it was last year or in years past.

However, what's changed a bit is the opportunity cost of doing a startup. Last year, tons of late stage companies were offering record salaries and equity grants. For many people, starting a startup meant leaving a lot of money on the table. Today, plenty of companies are doing layoffs and hiring freezes. There are still great jobs out there in tech, just a lot fewer of them than there were a year ago. So starting a company is a bit less of a sacrifice than it was previously. (Though to be clear, it's still a big tradeoff, and certainly not for everyone).

If you were considering starting a company today but feeling discouraged due to the tech downturn, hopefully this gives you a few reasons to reconsider. I believe that in ten years, we'll look back at 2022 as the founding year for plenty of awesome companies.

And if instead of starting a startup, you’re considering joining one, here are a few things you should ask when doing your diligence on an offer.

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Ravi Parikh
Co-founder & CEO
Founder at Airplane.dev

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