Y Combinator Advices Startups to Prepare ‘for the Worst’

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Y Combinator recently sent a letter via an email to its portfolio companies, advising them to brace up and prepare for the worst. 

Y Combinator invests $500,000 in a large number of startup companies twice a year, although this wasn’t always the case. The accelerator initially invested $150,000 but reduced it to $125,000 in 2020. These amounts have changed since Y Combinator launched, but its equity rate has been the same at 7%. 

Since 2005, the community of over 7,000 founders has funded more than 3,000 startups globally, with the companies having a combined valuation of $600 billion.

The Accelerator’s advice is due to the economic downturn in the global markets. Explaining that startups need to cut their expenses and change their tactics, the email read:

“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.”

It should be noted that one of YC’s portfolio companies, Shopify, lost 12% of its value this year, and Netflix saw a loss of over $54 billion in market value as its stock price fell by over 35%; there are several others.

Per TechCrunch, the letter stated:

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 slowdown 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

Best,

YC

Adding to this, Y Combinator stated: “PS: If for whatever reason you don’t think this message applies to your company or you are going to need someone to tell you this in person to believe it… please reassess your beliefs on a monthly basis to make sure you don’t drive your company off a cliff. Also, remember you can always reach out to your group partners.”

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