When Winter comes, you better be south of the wall

As said in the last articles, the tech world is dominated by unicorns: companies who create buzz and attract large investments. But as Emilien's six year old would say, unicorns don’t exist. After 10 years in business, we prefer to think of Adikteev as a Shetland pony: real, reliable and here to stay. 

This month, in light of the recent market turmoil and the bursting of the tech bubble, we want to talk about the importance of profitability and cash management.

What is going on here?

While it is almost summer in the northern hemisphere, it seems that the tech world just entered a long and very cold winter. No one really knows how long and how cold it will be but recent news seems to be announcing hard times.

After 10 years of a bull market boosted by incredibly low interest rates and “free money,” the pendulum is swinging in the other direction. We’ve just entered a bear market amid a challenging economic context: high inflation, higher interest rates, geopolitical instability and slower economic growth. 

Stock markets have already adjusted their valuations and after two years of insolent growth boosted by the COVID-19 pandemic, tech stocks have experienced a violent correction.

Just in case you missed it, here’s some recent bad news for the tech world :

1. Venture investments started to cool in Q1 2022 (even for Unicorns) and are now slowing down big time. 
2. In May 2022 tech giants including Apple and Google, lost more than $1 trillion in value.
3. A few weeks ago, Uber CEO Dara Khosrowshahi wrote a letter to employees discussing the business' plans to cut costs in an effort to decrease cash burn and increase profitability.
4. Two of the most aggressive and bullish investors have announced huge losses: $26.2Bn for Softbank (its CEO said they will slow down investments from half to 75%) and $17Bn loss for Tiger Global.
5. A few days ago, YCombinator (the biggest startup incubator in the world) sent a clear warning to all its companies regarding future fundraising
6. Massive staff reductions were announced by Klarna, Netflix, Robinhood and many more

From the YC founders’ letter:

“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

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.”

So long 40x ARR valuations; welcome back good old 10x

As shown in the chart below, the NASDAQ index is still significantly above its pre-pandemic level. The recent decrease could be a simple (yet very violent) market adjustment after an uncontrolled period of growth and skyrocketing valuations.

Indeed we went through a decade of overvalued companies allowed by abundance of free money, which led to the birth of thousands of Unicorns, with some of them lacking proper business models, decent unit economics and clear pathways to profitability. Actually, the word profitability itself was almost a swear word in VC jargon.

Overpriced companies and high levels of speculation are symptoms of a bubble, and at some point, the bubble explodes. The crypto market losing $200B in a day a few weeks ago is just another example of how crazy things can get when imagination supplants rationality. It took time but reality is catching up.

To be clear, we don’t think every startup should fail or shrink. We are only saying that it is not normal for startups to raise millions at hundreds of millions valuation just by putting trendy words on a pitch deck that doesn’t include a business model… 

How bad will it be? 

As explained above, the recent turmoil could simply be an adjustment and we can expect a return to a more balanced reality. However, the underlying macroeconomic and geopolitical context makes us fear a longer and more profound economic downturn, which will inevitably lead to slowed, flat or even negative growth for many companies.

For GAFAM, given their market position and their incredibly deep pockets, nothing will really change.

For smaller companies, the story might be different. Although there is still a massive amount of dry powder available, private companies valuations will keep mirroring public companies, which means that already adjusted valuation could further decrease, leading to down-rounds. 

Venture Capital has been a tremendous asset class for several years, but with book values potentially shrinking or growing slower, core KPIs will change (so long TVPI, welcome DPI). Also, LPs might become more careful in their asset allocation, which could make new funds more challenging to raise, leading to less money available in the mid-term.

As highlighted by YC, investment seekers may really struggle getting financed in the future and money will start to be expensive as interest rates rise to compensate for inflation. 

While the best companies will still have access to a lot of money in good conditions (yet adjusted), raising capital will become more challenging for tier 2 and tier 3 companies. 

Therefore there is an obvious risk that non-profitable companies will run out of cash in the next 12 to 24 months. Unless many of them become profitable shortly, there could be some big turbulence ahead, and unfortunately some bankruptcies in the end.

Luckily for Adikteev,  we are not too scared by that situation (yet vigilant and cautious, as always) because (1) we have been a very profitable pony from Day 1 and we have a very strong balance sheet, and (2) our underlying market (gaming) is supposed to be relatively resilient.

To be honest, it feels good to be on the right side of the Wall and to see that all of a sudden, many people  remember what EBITDA means.

What’s next?

While it’s nice to know that we’re in a comfortable position to weather the storm, we do have some advice for startups who may not find themselves in such durable circumstances. 

Your company is not profitable: Houston we have a problem! 

While lower valuation and dilution could be bad news for founders, it might still be the only viable option for some companies and should be considered seriously. 

Maybe you could be backed by your current investors, but from our experience don’t expect this to happen. VCs are rarely there when times get rough.

The best way to get through it is to avoid any financing rounds for the next two years. At least that’s what YC told their startups’ founders in their “10-point survival strategy”

Most importantly: don’t think you have time! Past crises have proved that surviving companies are the ones that adapted their costs the fastest. Start building a six-month profitability roadmap now and adapt your plan accordingly by adjusting costs and cash burn.

You’re launching your startup and looking for cash

“When the going gets tough, the tough get going”! This is the best moment to launch your company. Ok, the big party is over and you might not raise a $5M seed at a $20M valuation anymore. But if your team is strong, if your product is solid enough and if you have built a strong business plan with an achievable mid-term profitability target, you might still attract some investors. 

Money is not gone and investors will still need to deploy their funds. They will just be more picky and profitability will become a more important metric to achieve. 

With that in mind, there is no reason not to start a company now: if you succeed, you and your company will most likely learn what resilience stands for and it will make you stronger in the future.  

If you fail, you can still blame the crisis.

Your company is profitable: Don’t think it’s a cinch!

Do you feel safe because you have some cash in your bank account and a profitable company?

Stay focused! Things are about to become intense. In the coming months cash positive companies are going to become more aggressive to make the most of their position. Do not fall asleep.

As a company that survived several crises already, here is what we will most likely do and what some of your competitors might be doing as well:

• Focus on recruitment. Many talented people are going to be joining the job market and it is a good moment to reinforce the team
• Focus on gaining market share amidst competitors that might be struggling with profitability
• Actively look for investment and M&A opportunities at more decent valuations
• Secure financing options in case more cash is needed to ensure development

In a nutshell, we will do our best to leverage our strong financial health to become stronger.

So the question is: What are YOU going to do?