Recession: The Challenges for High-Growth Startups

In the last couple of weeks, much of the news in the tech world has been focused on company layoffs, unjustified high valuations and overvalued stocks of tech companies, as well as the expected slowdown in global economic growth. As a result, many companies, countries and people are already preparing for what seems to be an inevitable recession.

But why is this happening and what will be the impact on human capital?

For starters, many startups adopted a high burn rate strategy to acquire many customers (at any cost), with the hopes of increasing or even capturing a dominant share of their industries. Unfortunately, a large number of them are now facing tough times, as revenue is slowing down since everyone is becoming more wary with their spending. One of the first — or at least more visibly — reduced operating expenses has been payroll. Many startups have resorted to massive layoffs as a first line of defense against financial uncertainty. Some are even facing difficulties raising capital and are expecting it to become more expensive.

Taking into account investors’ recommendations, the main goal for most startups in the following weeks will be to ensure a runway of at least the next 12 to 24 months. This will also mean cutting costs on projects that are not core to the business or either delaying or pausing expansion to new countries.

It is not yet known if these aggressive cost-cutting strategies will save most of the suffering companies but the impact on human capital is already apparent:

• Employees' perception is that many companies see them as expendable resources. Given that, we could expect to see higher turnover among the employees who stayed and a subsequent decrease in retention.
• Employee morale and commitment will probably take a huge hit, since many had their close colleagues leave and also some leaders had to let go of most of their teams, which could potentially affect overall performance.
• Some of the well-performing employees who were laid off are being hired by direct competitors, bringing in best practices and possibly working on replicating competitive advantages from their previous employers.

For those who stayed to defend the fort, they can already feel the pressure of either turning profitable or becoming more efficient with fewer resources. No more unlimited marketing spend, unjustified hiring or aggressive expansion plans for most startups (even unicorns) for the months ahead.

Endless Possibilities for Employees

Due to COVID-19, we have already experienced accelerated changes in the nature of work and human interaction; and the transformation is visible across most industries. All these changes have also given us the benefit of having companies change their work-related policies to offer remote-first jobs, which has opened up not only the hiring landscape to a more global approach but has also brought more competitive compensation packages for the best talent.

This situation has started an epic poaching battle for top talent. Given that the most important asset for companies and global economies is still people, with the increase in skilled human capital demand, we are now standing on the precipice of a major challenge: our ability to learn for ourselves, educate others and retain talent.

So, for the still unemployed, there are a lot of possibilities but they will come at the cost of being able to rapidly acquire the most in-demand skills.

Hiring for Keeps

As people remain the main ingredient to produce value, becoming a developed and productive company will be limited by the ability to foster the talent needed to get ahead. Opting for massive layoffs will make more sense for companies that are not investing in human capital development but, at the same time, new and remaining employees will probably produce lower-quality results and will have less motivation to contribute to the company's goals.

A study done in 2021 showed that firms with highly-trained human capital were less likely to fire people as a first strategy to reduce costs, and were more prone to cut costs in other areas first. If we as leaders become more selective at hiring and focus on strengthening our employees’ skills and knowledge, we can not only receive better contributions from them but also accomplish a better alignment with the overall company goals and, thus, be more likely to achieve them (F. Scott Bentley, Rebecca R. Kehoe, and Hyesook Chung, 2021).

On top of the previously mentioned study, different research papers have found that historical market response to layoffs in the short term (less than 1 year) is primarily negative:

• Firms that engaged in downsizing experienced declines in market value in the period immediately surrounding the announcement date (Deepak K. Datta and Dynah A. Basuil, 2015).
• Employee downsizings had negative returns (Deepak K. Datta and Dynah A. Basuil, 2015).
• Negative effects on organizational reputation (Deepak K. Datta and Dynah A. Basuil, 2015).
• While financially weak companies that downsized exhibited positive market returns, companies with profitability above the industry average experienced negative wealth effects (Elayan et al.,1998 and Iqbal and Shetty, 1995).

As business leaders facing tough times ahead, we need to strive for better policies regarding employee compensation, managing layoffs, not over-hiring when scaling up and workforce development plans; examine other cutting-cost alternatives before turning to downsizing; and during uncertain times, refocus the company’s efforts on the core business. If not, we are doomed to face more growth challenges during financial distress.