Why it’s good to start a company when VCs aren’t writing cheques

Rick Baker, one of Blackbird’s co-founders, opened last week’s Sunrise event in Sydney with a commentary on the cycles of investment activity, making the case that we are at the dawn of the next cycle. 

It was an optimistic acknowledgement of the low mood of the Australian startup ecosystem, which could be felt in the conversations happening in Sunrise’s networking spaces. Founders have lived through the recent low point in the cycle – and are still feeling it. Many told me they’d come in the hope of attracting investment, but that the response from investors (many of Blackbird’s contemporaries were there too) was tepid.

Of course, the best companies are still attracting funding. When you’re as good as Multitudes, Springboards.ai, Mutinex or Vow Foods, you don’t have money worries. Their founders were all in chipper moods, contrasting the general mute in the venue. “It was a lot louder when I came two years ago,” one observed.

As my colleague Mary Hurley says, we’re in a “tumbleweed apocalypse”. And it’s enough to make you wonder about the wisdom of starting a company when your chances of getting funded are so depressed by macroeconomic factors.

I’ve been fortunate to have been involved in, or close to, the founding of several companies during periods of economic contraction: Stolen Rum (in the middle of the GFC), AF Drinks (at the beginning of the first Covid lockdown), Tracksuit (between lockdowns) and Ideally (amid our most recent recession).

Other than Ideally, which is still in its very early days, those companies all came out of the macroeconomic woods, grew quickly, and went on to create at least tens of millions of dollars of value each.

Of course, it’s also true that many companies founded in those periods didn’t succeed, and many founded during growth periods did. But what I’ve learned is that starting in hard times can give companies a powerful advantage.

If you can make it in the hard times, you can almost always make it in the good times.

Most things about starting and growing a company are harder in the hard times. People, often feeling despondent themselves, are less likely to be optimistic about your idea in the first place. Then, those you want to quit their jobs and work with you, cling to the security of their existing paycheck. Getting early traction while everyone’s having their budgets slashed is punishing. And that’s all before you get anywhere near getting nos from investors.

What that all adds up to is that product-market fit has to be very real. The conditions of customers being super strict about what they spend and who they retain are perfect for discovering whether you’ve created something with genuine, sustainable value. If you haven’t, the business is in for a rough ride in the long term. Periods of economic contraction happen roughly every seven years – so if you plan to be in business longer than that, you’re going to need to go through one. And, the data shows that it takes about nine years to go from a first investment to an exit or IPO, on average. So yeah, you’ll likely need to operate through at least one downturn.

Companies built in recessions know they can withstand the next one. Companies built in booms don’t. That’s not to say they won’t, but there’s no real way of knowing. This is what makes smart investors very keen on good companies during recessions. Those companies have proof of what I’m going to call a “macroeconomic moat”.

That is, their product is so valuable, or necessary, or just downright desirable, that people or companies choose to buy it or keep buying it even when they’re cutting their spend on everything else.

Competitive moats are important, too, but companies with both a competitive moat and a macroeconomic moat are the strongest.

Recessions also beg an interesting question about metrics and how we normalise them. I don’t have the data, but it stands to reason that a metric like net revenue retention (NRR) would have a higher top quartile in booms and a lower top quartile in busts. 

When budget cuts are universal, and B2B customers sometimes go out of business themselves, even the best companies will find it difficult to retain every dollar of revenue. I’d appeal to VCs to look at their data to understand this. I’ve seen NRR benchmarks lately that appear to be at least somewhat averaged using data from happier times, which might obscure a company’s excellent performance in the current economic climate or a company’s poor performance in future. Of course, this same idea applies to many other popular metrics.

Either way, the point is that a recession is a very good time to start a company, if you can. You get the gift of learning how good your product is. Which either saves you from wasting years on something that’s a bit shit, or means you create a company with the awesome long-term value of a macroeconomic moat.