Y Combinator warning to tech startups: “Plan for the worst. Good times may be coming to an end”

Y Combinator (YC) is one of Silicon Valley’s most renowned startup accelerators that provides funding for early-stage startups. Since its inception in 2005, over 2,000 tech startup companies have been launched through its accelerator program. Notable among them include Stripe, Airbnb, Cruise Automation, DoorDash, Coinbase, Instacart, Dropbox, and Twitch.

With the ongoing geopolitical events, economic downturn, and the sugar-high economy cooling off, Y Combinator is now sounding the alarm bell about the impending pain that awaits tech startup companies. In a letter sent to its portfolio companies this week, YC warned that the party is over and good times may be coming to an end for startups and the venture market.

“No one can predict how bad the economy will get, but things don’t look good,” the influential Bay Area startup accelerator wrote in a letter to portfolio founders that was first published by TechCrunch. “The safe move is to plan for the worst.”

The warning to startup founders comes just a week after a series of layoff announcements from tech companies big tech companies reportedly lost $1 trillion in market capitalization. Just last week, SoftBank Group Corp., one of the biggest VC firms in the world, announced it would start being “more selective” in its investments. That announcement also followed a loss of $27.7 billion from investments made by its Vision Fund in the just-ended fiscal year.

Meanwhile, YC  also offered advice to startup founders on how best to weather the turbulent market. A copy of the letter is also posted on the YC website. You can read the full letter 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 cannot 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.[1]

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 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,[2] don’t expect another round to happen at all until you have obviously hit product market fit. The Series A Milestones[3] 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.[4]

Best,

YC