Tips for Startups to Survive a Recession

It seems that “winter” has already permeated the startup ecosystem in Mexico and Latin America. Russia's war in Ukraine, rising interest rates, inflation without a ceiling in some countries and the air of economic recession in the US have put the brakes on investments in startups.

Amid a series of layoffs at different startups in the region in recent weeks, Transactional Track Record (TTR) data indicated that for the second quarter of 2022, US$2.426 billion were invested in Latin American startups, which is a 54 percent drop compared to the US$5.353 billion invested in the same quarter of 2021, reflecting investor caution in the face of an economic slowdown.

Along with this, and due to the poor performance of the main Wall Street indexes in the first half of the year, some companies that had achieved unicorn status in the last two years are no longer so, as their valuations fell after listing on the stock market, which has reduced new investors interest.

It is for this reason that one of the main recommendations for startups that are still receiving investments or have recently added them to their portfolios is to be careful with the resources available as the pressures on demand in the coming months will make it more difficult to achieve results and profits.

Acting Early in the Face of Recession

Pessimism regarding private market portfolios and the drums of a recession are already being felt more strongly. As a result, the returns of venture capital funds globally are already seeing cuts and in 1Q22, 68.1 percent of these funds had a fall in their valuations, an effect that could extend strongly to Latin America, as 62 percent of investment rounds have foreign capital.

In the midst of an economic recession, as has happened before, venture capital investment slows down and it is much more difficult for companies to raise money, especially for those with long terms to generate profits.

As a result, competition among investment funds is discouraged, capitalization rounds are smaller and startup valuations are lower.

One of the most propitious moves for those in charge of a startup is to plan for a bad economic scenario and evaluate how bad the situation could be for their company. In this way, one of the best strategies is to reduce operating costs to extend runway.

In addition, keep in mind that if a startup wants to raise capital in the coming months, it is very likely to be doing so in the middle of the recession, which is why the valuation may be lower than expected even if the company is posting good results, so raising money from investors cannot be the only plan to survive. Analysts have pointed out that the coming recession is inevitable and others, such as Wells Fargo Investment Institute, say that it has already begun.

Business Maturity and Market Knowledge

Even with a recessionary environment, high inflation and rising interest rates, the outlook for startups and unicorns in the region has not weakened at the pace predicted in recent weeks. In the first 11 days of July, multimillion-dollar mergers and acquisitions have been completed, which have injected dynamism into local markets.

One of the reasons for this phenomenon is the adjustment in valuations, especially for startups linked to the technology sector, as the correction makes them more accessible to acquisition by foreign companies or funds.

But there is another key factor: the maturity of the teams leading startups in Mexico and Latin America. Talent is much better than it was 10 years ago and this has led to CEOs of different unicorns throughout the region betting on becoming angel investors in other ventures.

Such has been the evolution of the ecosystem in the region that in 2021, at least US$19.5 billion was invested in the region, triple the investments in startups that were presented in 2020, according to figures published by Crunchbase.

At the same time, the preparation of the teams within a startup is definitive for attracting new investments, because when the objectives are clear, it is easier to show the potential of the company to venture capitalists, combined with a broad knowledge of the market and the differential that can be marked in this, even in an environment of recession.

Maintain Cash Flows

As is the case with financial institutions, fintechs are going through a period in which asset quality may become weak due to high inflation and rate hikes by central banks.

These factors, which according to analysts could continue to increase at least in the short term (inflation-interest rates), would lead to low demand for credit from households and companies, while the latter and venture capital funds could delay their investments until they see a better economic outlook in the countries of the region.

Especially for fintechs, they may face greater pressure if, in order to compete with traditional banks, they must also increase their commissions and interest rates to compensate for higher financing costs. In the Mexican case, Non-Banking Financial Intermediaries (NBFIs) may also face a similar scenario, according to a report recently presented by S&P Global Ratings.

Finally, profitability becomes a keyword for emerging companies that want to survive a period of recession, since in the midst of high inflation and lower demand it becomes more difficult to achieve projected growth figures, so safeguarding cash flow is essential as it is a focus for investors who bet on these projects.