What companies should strive for in a down market

Photo by Christopher Michael

The COVID-19 outbreak leaves today’s markets in flux, and naturally there are two general categories of thought when it comes to how venture capitalists will react. 1) Venture firms will sit out the next few months and not deploy capital as they focus on supporting their existing portfolio, or 2) Venture firms are open for business, knowing that incredible businesses were built during the last economic downcycle (aka: the 2008 financial crisis).

At Floodgate, our investment strategy remains largely unchanged. Our mission is to back founders who have the grit, vision, and courage to not only survive, but actually thrive in an economic environment where there are no guarantees the next funding round is right around the corner. Even over the last few years when it seemed that capital was aplenty and companies without a clear path to profitability were able to raise large rounds of funding, we’ve encouraged founders to be practitioners of Intelligent Growth. (So much so that we teach a class of the same name at Stanford!) 

What venture firms look for in down markets 

The premise of Intelligent Growth is that a startup needs to hack value before it hacks growth. That’s the key message here: Especially in a downturn, companies must be sure they’ve reached product-market fit before they prioritize growth. Does that feel counter-intuitive?

Over the past few years, when venture funding seemed abundant — more funds were popping up and existing firms were raising larger funds — companies and VCs alike were prioritizing growth, sometimes in the absence of a sound business model and often before product-market fit was clear. Companies started taking a “growth at all cost” approach to reaching triple-digit growth rates — even when the cost of acquiring customers continued to outpace the lifetime value of those customers, margins were deteriorating, or there were other signs that product-market fit had not been achieved.

In fairness to founders, they were often solving for what they thought would get their companies noticed and funded, so the ecosystem started to confuse high growth rates with evidence of product-market fit. But how is a founder to know if product-market fit has been achieved? There are many definitions of product-market fit, but they generally center around creating moments of delight for customers that are so compelling, that instead of the company pushing its products to customers, customers are pulling the products from the company.

“Growth at all costs” leads to fake progress

Unfortunately, what those concepts often fail to take into account, especially in the early days of a business, is whether the unit economics are (or will become) attractive and whether the company can ultimately grow in an efficient manner.

Take the example of an ecommerce company who uses free credits to get customers in the doors, only to have the customers churn once the credits expire because the service itself was not fundamentally valuable. The company may be able to use its own capital to, in effect, buy growth via net-new sign-ups, but without an ability to retain and monetize an active customer base, the growth is clearly not sustainable. So while the company may appear viable from the outside, the inflated growth rate creates an unstable foundation. It is, in effect, fake progress

Finding product-market fit in a down market 

A much more sane approach to building a company is to not only strive for product-market fit, but to also position yourself competitively in your ecosystem with a business model that can evolve to let you be self-sustaining someday — to control your own fate. This does not mean you need to monetize on day one, of course, but rather that you always maintain a sense of what you’re building toward and whether the ecosystem you play in (your customers, suppliers, partners, and competitors) will accommodate your business model. To learn more about how to solve for not just creating a Minimum Viable Product but becoming a Minimum Viable Company, even in the early days, read this blog post by Floodgate co-founder, Ann Miura Ko.

To be clear, growing intelligently does not run counter to growing quickly or blitzscaling. When does a start-up begin to Blitzscale? Entrepreneur Reid Hoffman like to say this happens when “you’ve ironed out the product-market fit, you have some data, and you know what the competitive landscape looks like.”  

Intelligence growth starts with creating value

There’s a time and a place to invest in scaling your company, but that time is not before you’ve attained product-market fit; growth alone is not evidence of that magical moment. Whether we’re in a bull or bear market, you want the fundamentals of your business to be sound so you’re not dependent upon a large next round of funding to buy you more time.

Stay calm and grow intelligently, my friends. 

Image credit: Christopher Michael
We believe culture, diversity, and operational excellence are a key part of building truly great companies. Learn more at www.operatorcollective.com or on Twitter and LinkedIn.