The 10 mistakes most founders make in a downturn

By now we probably all understand that the current market situation in the tech industry is not just a blip, but likely a serious downturn that could last many months or even years. I’ve been through two downturns as a startup founder (2000/01 and 2008/09) and am now experiencing this one as a VC.

Things can get bad quickly in a downturn. For example, in the 2000/01 dot-com bust, my company had to lay off more than half of our employees over a span of two years. At one point we were about two weeks away from running out of cash and had to raise an emergency round in which all founders were diluted to almost 0%. We had to buy back our way into our own company. Sometimes you have to do unusual and painful things to survive.

But a crisis can also be a huge opportunity. My first startup was the no. 4 player in our market when the dot-com bust started. Three years later, we were the clear no. 1, twice as big as the next competitor. Why? Because the first three players — all overstretched and failing to react quickly — had gone out of business.

Survival in a crisis is never pretty. There is no perfect, clean way to achieve it. But it all starts with not making too many mistakes.

Here are the top 10 mistakes I’ve seen founders make — and I made them all myself:

1. Failing to fully accept reality

The last 10+ years have been great for the tech industry. Apart from a couple of short blips, things have just been going up. Growth rates increased, valuations rose, exits were amazing.

It’s hard to accept that a long bull run like this has now probably come to an end. Particularly for younger founders who have never seen bad times, this is hard to wrap their heads around. When you don’t have a frame of reference from experience, understanding intuitively what a crisis might look like is nearly impossible.

The natural reaction is denial: This can’t be happening. It’s just going to be a short blip. Maybe it’s bad for other people, but we are not going to be affected. OK, maybe we are affected, but it won’t be that bad.

Denial is very dangerous because it prevents you from thinking carefully about the situation and from acting quickly and deliberately. Great companies have been killed in downturns because management was delusional and thought that reality didn’t apply to them.

How do you prevent that from happening? Connect to reality. Read about what is going on in the market and the broader economy (but get your information from reputable sources such as the Economist or the FT, not Reddit forums). Talk to people about how they perceive the situation. Read up on how previous downturns have played out and how companies ended up surviving and thriving.

The faster you accept that things are different now and get a clear understanding of what is going on, the better you are positioned to act effectively.

2. Acting too slowly, then too dramatically

A consequence of denial is of course that many people act way too slowly in the face of a crisis. They procrastinate in the hope that things will soon look better.

Then things get really bad, reality suddenly hits, and they switch to the opposite: Overreacting, breaking a lot of things, taking dramatic measures that have more to do with the need to signal decisiveness than with measured action. For example, some companies turn to huge rounds of layoffs after having failed to act for a long time initially. These sudden actions often end up instilling much more damage than necessary.

The trick is to find the right balance and the right pace of action, in a crisis more than ever. Act quickly, but think hard about what is really needed.

3. Failing to be honest with your employees, or spreading panic

Closely related to finding the right balance in actions is the right balance in communication with your employees. They are not isolated from reality. They read tech news sites too, and they talk to people in other companies. They know what is going on in the market, and they will want to know how their own company is affected.

The only way to deal with this effectively is to be honest and transparent. Don’t try to sugarcoat what the situation is. Share what your perception of the market is, what you think it means for the company and how you see the way forward. Don’t oversell strength, and don’t pretend that it’s going to be easy. People see right through that.

Some founders hesitate to be honest with employees because they fear that people will quit. In my experience, quite the opposite is true: The best employees, the ones you want at your side to get through this downturn, are exactly the ones who appreciate being treated like adults, being trusted with the truth. They will be more motivated to stay on board and help.

Sometimes founders fall into the opposite of sugarcoating: Spreading panic — telling employees that things are much worse than they really are, maybe in an attempt to prepare them for the worst or just to relieve the founder’s own stress and mental pressure. It’s easy to make that mistake when things are going south quickly, but it’s very damaging. Panic can grind a company to a halt and will make things much worse.

What employees want to see in a difficult situation is a leadership team that is honest, transparent, realistic, calm in the face of adversity and following a well thought-out plan.

Side note: This is often an issue for board members as well. Some board members think it’s important to keep the management team motivated by spreading unrealistic optimism. Then, when things get worse, they sometimes suddenly switch into panic mode. Obviously that’s not helpful at all. The job of board members is to bring steady realism to the table.

4. Not having a clear plan with 3 scenarios

A prepared mind is essential when navigating a downturn. The last thing you want to do is make decisions under immediate pressure without having a good understanding of the consequences and influence factors. The only way to avoid that is by being prepared and having thought through things in advance. This is best done by preparing scenarios and discussing them in-depth in your management team and with your board.

You should build at least three scenarios based on your financial plan:

a) The (mildly optimistic) base case: Things are cooling down, but the company has enough runway, can take advantage of new opportunities and continue to grow.

b) A (realistic) downside case: Growth is getting much harder, or there could even be a reduction in revenue; the fundraising environment is tough, and it’s hard to raise new money, at least at a good valuation.

c) A (really bad) crisis case: Revenue is declining substantially; the runway shortens quickly; raising money is very tough.

Once you understand which measures have to be taken in each scenario for the company to survive, it’s much easier to take the right actions early enough depending on where you land in reality.

5. Not empathizing with your customers

When things feel bad for your company, it’s easy to forget that your customers are probably affected too. Particularly if you’re selling to customers in the tech industry or other sectors that experience a downturn, this is essential to consider.

When you are thinking about how to cut costs, your customers are doing the same. And maybe your product is going to land on the list of non-essential items that can be cut. The danger of a substantial revenue decline is very real in a downturn, across many sectors.

The way to deal with that is to talk to your customers more than ever. Understand how they are doing, what measures they are considering. Find out how you can help. For example, during the early days of the COVID crisis, some B2B SaaS companies granted discounts to customers who were particularly affected, such as those in the travel industry. These customers were very grateful and came typically back at full price and with larger packages after the crisis.

In any case, getting an early read on how your customers are doing is essential for revenue projections. The more you understand the dynamics, the earlier you can act.

6. Not overcommunicating with all your stakeholders

Navigating your way through a downturn is exhausting. More often than not, the first thing founders compromise on is communication. They start to not update their board and investors as often as usual. They struggle to talk to employees frequently, they rarely reach out to customers.

That’s all understandable. It’s tough to share bad news, and hard to hear other people’s concerns. The natural reaction is to close yourself off.

But that’s very dangerous for two reasons: First, you need all the help you can get. People are willing to help, even in the toughest circumstances, but they can only do that if they know what’s going on and what you need. Second, surprising people in a bad situation can have dire consequences. When your board learns about how bad things are when it’s already too late, it might be impossible to find good solutions.

So as tough and strenuous as it is, overcommunicating is more important in a downturn than in normal times.

7. Not getting the right kind of advice

Understanding what kind of advice you should trust as a startup founder is complicated even in good times. There are always more than enough people who are willing to offer their opinion, but figuring out who is both competent and trustworthy is not easy.

This is even more important in a difficult situation. Particularly when it’s not clear where the market is going, you can get wildly diverging advice.

When you decide who to trust, ask yourself three things:

a) What are the incentives of this person to give you a particular kind of advice?

b) What does this person know about your business and the relevant market? Are they competent enough to judge the situation?

c) Does this person have direct experience with this kind of situation, i.e. dealing with a tough downturn? For example, growth consultants rarely have the best skills to help with cost-cutting measures.

Interestingly, when things get very tough, the best kind of advice is often very simple. When I was a startup CEO in the middle of a deep crisis, I was lucky enough to have a board chairman who was great at this. I still remember how he, on a particularly dark day, guided me through a simple thought process to figure out what we needed to do to survive. He didn’t necessarily know much about the details, but he knew what really mattered — just four numbers. These ten minutes brought more clarity to the way forward than weeks of discussions in the management team before, because everybody was way too caught up in nasty details and strong emotions. Look for people who can bring wisdom to the table.

8. Spreading the pain equally when making a cut

Many, if not most companies in a downturn end up having to take the hard step of letting some employees go, or even instill substantial layoffs. This is painful for everybody involved, most so for those laid off, but also for remaining employees and the management team that has to make the hard decisions.

A natural reaction is to spread the pain equally between all departments and offices: For example, everybody has to reduce their staff count by 10%.

That’s understandable and sounds “fair”, but it’s not the best thing to do for the future of the company. There are differences in how much any given team or department can contribute to the way forward. Having a strong sales team is more important than ever in tough times. Product should concentrate on the product lines that really matter and avoid distractions. And G&A has to be leaner than ever.

9. Killing your growth engine and competitive advantage

Related to the previous point: Many founders overshoot with their cost-cutting measures because they’re panicking and end up killing what enabled the company to be successful in the first place. You then end up with a company that might be barely able to hold on for survival, but can’t go back to strong growth once the worst is over.

Thinking hard about what your company really needs not only to survive, but also to expand its competitive advantage is key. Be selective and deliberate about where to cut costs. And similarly, there might be opportunities to selectively invest to set up the company for future success. The positive thing about tough times is that you often can hire great talent and get deals on all kinds of things. And as mentioned above, a crisis can be a huge opportunity to win market share from your competitors who are doing even worse.

10. First feeling entitled, then falling prey to imposter syndrome

A final point about founder psychology: When you start your company in boom times, it’s easy to get overconfident and feel entitled to success. In the past few years, VCs fought over investment opportunities, investors bent over backwards to be founder-friendly, the tech press celebrated founders and hot startups, and talented people flocked to join startups. When the downturn hits hard, all of this goes away.

I experienced this quite dramatically in the dot-com boom and bust (and so did many of my friends). One day the press celebrates you as a young, supposedly brilliant Internet entrepreneur, and just two months later you are almost a social pariah just because you’re working in the tech industry. The general mood turns quickly, and your first reaction is to be offended. Didn’t I do an amazing job building this company? Don’t I deserve success and admiration? Why are investors suddenly asking for better terms, don’t they see how amazing my company is? Why is the press suddenly ignoring me? And so on.

After some reflection, it’s natural to drop into the opposite mental position. You start asking yourself if maybe all of this success was fake. Maybe you were just one of the boats that was lifted by the rising tide. Maybe you’re not cut out to be an entrepreneur.

Both positions are of course wrong. First of all, starting and growing a company and getting it financed is hard even in the best of market conditions. If you managed to do that, you’re already part of a very small group of people, and it’s more than likely that you can deal with tougher times as well. But on the other hand, no, nobody owes you anything. As an entrepreneur, you have to prove every day that you can pull it off.

Originally published at https://innospective.net on May 21, 2022.
Picture: Kenny Eliason