Analysis

December 15, 2022

Are early-stage startups faring better than growth companies in the economic downturn?

Early stage startups haven't had to lay off staff and cut costs aggressively as later stage companies... yet


Jennifer Keiser Neundorfer (left) and Maren Bannon, cofounders of January Ventures

Some of Europe’s best-capitalised later-stage companies have shed staff and trimmed down on non-essentials to prepare for leaner months ahead, as the effect of worsening business and economic conditions takes hold. 

But that’s yet to trickle down  to the earlier stages, with pre-seed and seed-stage startups faring reasonably well, according to a recent survey by seed-focused VC January Ventures. 

Of the 442 startups surveyed — 137 of which are European — those in their earliest stages have avoided the big staff and spending cuts that have rocked later-stage companies and Big Tech. Yet, the majority have less than 12 months runway. 

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So that begs the question: are early-stage startups more immune to economic headwinds than larger companies, or are they not moving quickly enough to cut costs?

Early-stage startups avoid layoffs

Currently, funding is generally harder to raise at all stages. But while investors have pulled back on late-stage investments (companies at Series C+ have raised half of what they raised in 2021, according to Dealroom data) early-stage funding has proved resilient. European startups have raised $4.5bn in early stage funding (pre-seed to Series A) so far this year, compared to $3.8bn in 2021.

That funding has scaled back less at the early stage could imply that cuts to headcount have been less necessary than at later-stage companies. 

While Big Tech companies such as Amazon, Meta and Stripe have laid off thousands of employees this year, only 7% of pre-seed and seed-stage companies in Europe have reduced the size of their team. 

“While it may seem surprising that pre-seed/seed-stage founders aren’t laying off in a time like this, it is consistent with what we’re seeing in our portfolio,” says Maren Bannon, cofounder and managing director at January Ventures. “Early-stage teams, particularly those led by women and people of colour, are lean — there isn’t a lot of room to cut. These founders weren’t the ones raising hundreds of millions at inflated valuations."

In general, Bannon says that these early-stage startups have more manageable cost structures, as founders at this level weren’t overzealous in their approach to hiring and scaling in 2021.  

Early-stage founders are also used to “being scrappy and doing more with less”, adds Bannon. Still, 2023 will prove challenging for startups who will have to balance stretching out runway with “showing metrics to raise follow-on capital”. 

2022 sees less cost cutting than 2020

In 2020, as the pandemic caused many businesses to ground to a halt, 81% of early-stage startups in the US and Europe moved quickly to cut costs, including laying off staff, cutting compensation and reducing spending on HR and benefits software, sales and marketing software, developer tools and go-to-market spend. 

This year, only half of respondents in the US and Europe have taken action to reduce costs. 

“2020 felt like a jolt to the system, and founders reacted quickly. Many founders felt burned by their quick actions when the market bounced back and even accelerated,” says Bannon.

“Early-stage founders have reacted more gradually to this market contraction — it’s taken more time to trickle down to pre-seed/seed stage, and founders keep hoping things might quickly bounce back like 2020. But lack of rapid action could put a lot of these startups at risk.”

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While there is no blueprint for how startups — even those seemingly doing well — should protect themselves in these times, experienced founders and investors typically advise to be conservative with spending and focus on the "boring" business fundamentals.

The majority of early-stage startups have short runways

72% of European founders surveyed said their companies have less than 12 months' runway — in the US that figure was 84%. 

“European founders are used to doing more with less, making runway last. They've had less access to free-flowing capital than their US counterparts,” explains Bannon.

While less than 12 months of runway might sound frightening to some founders, short runways are a “reality” at early stage, Bannon sats.

It’s rare for companies at pre-seed/seed stage to have more than 18 to 24 months' runway — especially in a market where investors have “dramatically raised their bar, and the days of raising back-to-back rounds are over”, she says.

But while funding might be tougher for founders right now, there is a silver lining for startups on the talent side. 

For the last three to five years, it was hard for early-stage startups to compete with the base pay, bonus plans and equity options offered by growth-phase and Big Tech companies, but mass layoffs have reduced salary expectations, says Bannon. 

Now, early-stage startups that are well-capitalised are much more able to compete for top-tier talent.

Investors cool on dealmaking

In the eyes of founders, current market conditions are causing investors to slow their investment pace. 

Many are making fewer bets on new companies, and are instead choosing the safety of backing people they know, said 38% of respondents. 

This might prove problematic for diversity. Investors and founders are already worrying that the current slowdown in funding and economic growth will cause VCs to reverse their efforts to back diverse teams.

“One challenge during a downturn is it tends to hurt diversity,” Bannon says. “The reality is that there was a lot of lip service about diversity and not a lot of substantive, structural change.

“The networks in venture are still narrow, and in downturns investors retreat to their networks even more. This creates more friction for female and underrepresented founders.”

Indeed, Atomico’s 2022 State of European Tech report revealed that all-female founding teams accounted for 6% of all funding rounds in 2022, but only 1% of the funding raised. This statistic has been gradually worsening since 2020, when all-female founding teams won 3% of total funding raised.

Miriam Partington

Miriam Partington is a reporter at Sifted. She covers the DACH region and the future of work, and coauthors Startup Life , a weekly newsletter on what it takes to build a startup. Follow her on Twitter and LinkedIn