Tech Startups Will Weather the Storm

Markets are always in flux, randomly walking between gains and losses, but sometimes macro factors conspire to create sustained volatility. In 2022, we saw unusual supply constraints — lingering post-coronavirus supply chain issues, a persistently tight labor market, and Russia’s invasion of Ukraine — converge with high demand — partly fueled by heavy government stimulus during the first two years of the pandemic. Yet, we know tech startups will weather the storm.

In March 2022, right after Russia invaded Ukraine, the Fed started raising interest rates to battle inflation (the first hike in over three years), the inevitable result of too many dollars chasing too few goods and services. Ultimately, the sheer complexity of overlapping risks contributed to volatility, as investors were forced to constantly adjust their assumptions.

The Macro Factors Driving Volatility

For tech startups, this new environment is obviously challenging: Business customers are cutting costs and hunkering down as the Fed enacts aggressive measures to combat inflation, and consumers are simultaneously feeling the pinch from both inflation and high borrowing costs. Likewise, this is a season of economic pain for businesses: High borrowing costs and reduced demand are compressing margins, and some industries face persistent labor shortages.

For startups that sell to businesses, however, this pain creates new opportunities as forward-thinking companies look for permanent, technical solutions to these cyclical problems.

The Calm Within the Storm for Startups

Productivity gains from software, which have been hard to discern in the last decade, will become blindingly evident as new AI, such as ChatGPT, abolishes all manner of drudgery. Every employee will now command a small army of AI assistants that understand complex natural language — no code required.

To pick just one example, consider that employees can directly query data lakes using natural language, enjoying a level of access previously reserved for data scientists with specialized skills. Any startup will be able to incorporate the latest large language models into their products using tools provided by Microsoft and Google. (Microsoft is reportedly investing $10 billion in OpenAI, which launched ChatGPT late last year and grew to 1 million users in only a week.)

A downturn can also catalyze “home improvement” projects that businesses have been putting off.

For example, now is a great time for a cybersecurity upgrade, especially in light of recent high-profile hacks and ongoing ransomware attacks. (LastPass, a cloud-based software company for storing passwords, suffered a major intrusion via an unsecured employee laptop.) This type of internal project is less disruptive during a lull in customer demand, plus organizations know they will get a good deal in today’s market.

The Importance of Technology in a Persistently Tight Labor Market

For companies to retain talent — especially younger workers — technology that enables remote work is crucial. An odd feature of the current downturn is the persistently tight labor market. Even after aggressive hikes from the Fed, overall unemployment in the U.S. remains at a historic low, while some industries face acute labor shortages.

The pandemic was a giant (and mostly successful) experiment in working from home, with the result that workers now expect such flexibility. For tech startups, the good news is that a broad array of technology is necessary for remote work, not only communication tools, but also anything that helps people collaborate asynchronously and anything that makes cloud-based software safer and easier to use.

A Shift in Investor Preferences

Looking ahead, robotic automation shows huge promise. I recently caught up with the CEO of a Fortune 500 company, who shared how the pandemic had accelerated his plans to automate several factories. His original plan had been to upgrade by 2030, but labor shortages and the risk of quarantines dramatically improved the economics of a large, upfront investment in robotics.

This CEO explained that a side effect of robotic automation is better visibility into the manufacturing process. The visibility will streamline both operations and supply chain management — things he needs to do anyway in this new, less-forgiving environment.

As robots get smarter, lighter, and cheaper, I expect them to continue moving beyond factories and into skilled trades, healthcare, and even consumer applications. (Someday, we’ll look back at the original Roomba and laugh!)

The Implications for Tech Startups

For tech startups, there is no question that investor preferences have shifted, and a historical overemphasis on top-line growth has been replaced by a more disciplined focus on (a path to) profitability. Part of this shift is due to the impact of tighter monetary policy on tech stocks. In 2022, the Nasdaq composite fell more than 30%, while the yield on short-term treasuries increased to 4.5%. At some point, the Fed will finally loosen up, but it is unlikely that short-term rates will return to zero anytime soon.

In Closing

The days of relying solely on fundraising to survive are over. For startups solving real-customer problems, this will be a welcome development as overfunded competitors exit the marketplace. Founders will also find that by growing into sustainable businesses sooner, they are less dependent on the whims of investors and more in control of their destinies.

My parting advice to founders is this: Embrace these choppy waters because they create new problems to solve for your customers. The old equilibrium of easy money and inflated asset values has passed — and that’s ultimately good for everyone.

Featured Image Credit: Annie Spratt; Unsplash; Thank you!