Why great startups are built in lousy times

Thanks to Liza for reading this for me, she’s the best. Thanks to Ada for not falling asleep until after 1 AM last night so that I could write this while only half sentient. — Alex

Another week, another massive set of tech layoffs. After Microsoft and Google and Amazon announced cuts, Spotify detailed a tranche of layoffs this morning.

Here’s TechCrunch on the news:

Music streaming service Spotify has announced that it will be conducting a round of layoffs that will impact around 6% of its global workforce. In its most recent earnings release, the company said that there were 9,808 full-time employees working for Spotify. Today’s move will impact around 600 employees.

It would be easy to look around the tech market today and fret; tech valuations remain depressed, companies large and small are trimming costs, and it’s hard to find an optimistic voice when it comes to near-term growth prospects for startups and incumbents alike. So, tech companies are in trouble?

Not really. Not only are big tech companies cutting only a fraction of their recent headcount growth — more here — they remain intensely profitable. Sure, Spotify’s layoffs are a bit different as the music giant is not generating GAAP net income, but as it was free cash flow positive even before it let hundreds of workers go, it will likely only generate even more cash in the coming quarters.

The market for tech jobs, then, is worse than the market for tech products it appears, and most of the staffing cuts appear to be more a reevaluation of near-term growth prospects than an admission that the underlying model of tech majors is not working; it is.

Still, you might look around the technology news landscape and worry about startups. After all, following a period of intense optimism and investment, many young tech shops are struggling to find their way in a less risk-on market, forced to strike a new and somewhat contradictory balance between cutting their burn and keeping growth as strong as possible.

Don’t worry. The startups that raised too much during the 2020-2021 boom that now cannot find a buyer — or more capital — and die on the vine were not the companies of tomorrow. Even more, less exciting economics times often give birth to startups that become the majors of tomorrow. (Here’s Paul Graham on the subject.)

As far as the conventional wisdom goes, you have likely heard something like the following in the last decade: More conservative economic times often give birth to interesting, and powerful new startups. Examples are not hard to find to back up the concept. Dropbox and Airbnb were founded in 2007 and 2008, respectively, folks note, and today the two companies are worth nearly $75 billion on a combined basis.

The why behind that particular chestnut is what I want to explore a little bit today.

There isn’t a single reason why building a winning startup during a period of less frenzied economic activity can yield outsized outcomes. There are many. My list is not comprehensive, but it’s long enough that I have consolidated into three buckets: talent, competition, and founder DNA. Let’s have some fun!

Talent

During boom times, startup employees are constantly evaluating their current gig against Big Tech money, and rival startup jobs. Rip the carpet out from under the tech job market, and startups that have an interesting idea and market traction may discover that:

• The talent pool is suddenly deeper: Google and Microsoft and Amazon and Shopify and Spotify have cut staff in the last year, putting tens of thousands of tech workers back into the job market. That means that talent previously locked inside of what were at least perceived to be cushy jobs is now available. Those workers are also now likely a bit hungrier than they were.

• Less job-hopping: Not only are there likely more, and hungrier tech workers on the market for startups to try and hire today than back in 2021, they are also more likely to stick around. Hiring is expensive, onboarding is tricky and time consuming, and institutional knowledge is not gained overnight in the same way that it is lost if someone key bounces to a new gig. Less voluntary employee churn should mean that startups truly onto something new and exciting today can build atop a more stable — and therefore cheaper, more ramped, and better equipped — workforce.

• Better comp ranges from the employer perspective: The cheaper bit is worth another moment. During boom times, tech workers can run an interview process, get an offer, and then use it to whack their present-day employer for more money. As a wage earner, this is fine by me. For startup founders exhausted at the idea of competing with, say, Google for employee loyalty, just holding onto workers can prove incredibly expensive. But if Google is cutting, not only are there fewer chances for staffers to demand more money, they are also likely more willing to see their total comp grow more slowly. Again, not great for workers, but for startups the cash savings could prove material during periods of market reset.

Competition

The competitive landscape also improves for startups during a downturn. Back in the last tech boom, we saw venture capitalists fund lots of companies directly competing with one another. Many won’t make it. That’s fine. Let the strongest survive.

Apart from fewer startups squabbling over the same, often nascent customer base, there are other advantages to building when the overall temperature has been turned down in startup-land:

• It’s cheaper to make noise: The ad market is currently somewhere between the toilet, and the sewer. That means that, to pick one example, it’s cheaper to buy ad space if you are a startup looking to put a bit of capital into paid acquisition. Hell, I suspect that even space at conferences is going to get cheaper. As someone whose day job is partially predicated on advertising and conferences, this isn’t great news for my ability to get a raise in 2023, but for startups who want to make max noise per dollar it’s good news.

• It’s easier to stand out: Fewer startups raising means it’s easier to get folks to care about your round. Fewer startups launching means it’s easier to make a splash on Twitter. The list goes on.

• Lower pricing pressure: And with fewer startups competing in the same space, pricing pressure will lessen. Think about the corporate spend space where Ramp and Brex and Airbase compete today. Not only are major players in that market often working as hard as they can to give away their products for free, Airbase took it a step further to lower effective pricing even more. (Conversely, this is why competition matters to keep consumer prices low, but for startups not having a direct competitor raise more capital and then use it to debase their products from a pricing perspective is super good.)

Founder/Startup DNA

This is a bit less concrete, but hear me out:

• Restrictions breed creativity: If you can’t solve every problem with money, you find other ways to get around issues. This is harder to do when money is cheap, as it may appear expedient to simply spend one’s way out of a problem. But startups that don’t have that luxury may find themselves just as far along as other companies in time, but with a more innovative operating structure, sales motion, and pricing scheme.

• Less chance that you get high on your own supply: When the tech market is down, there’s a smaller chance that everyone around you tells you that you, the founder, are the third coming of Jesus (after Jesus, and James Hetfield). This may help founders keep perspective, and bear in mind that until they are free cash flow positive they are effectively renting their CEO chair.

• Less chance that you get high on investor supply: Venture investors are effectively momentum chasers. When times are hot, they are aggressive and complimentary. When times are cold, they are conservative and flinty. Investors not gassing you up with cash and honeyed words is probably both healthy for founders’ heads, income statements, and valuations.

• Less chance to conflate partying with work: Miami.

A few caveats: A full-blown recession will suck for everyone, no matter how crafty founders get to keep building. And all the above only holds true if there is a real innovation afoot. Airbnb did create something new. Dropbox rode the then-emerging cloud model brilliantly. I doubt that hard times will help the fifteenth company working on a niche neobank that is simply a GUI reskin of someone else’s banking infra; the opposite, actually.

But for startups with a truly good angle on the market busy building what’s next, a calmer, quieter, and less insane market for tech talent and spend can really prove a winner. I can’t wait to see who comes up next.

The featured image on this post is an excerpt from a piece shared by the Birmingham Museums Trust, whom I wish to thank.