An intimate understanding of macroeconomics often falls into the “useful, but not entirely necessary” category for founders.
The complex interplay of economic factors and the challenge of discerning their impact on one’s business could result in looking at the macroeconomy from the rearview mirror, rather than proactively addressing it and planning against it.
It certainly doesn’t help that founders are already juggling roughly 1,789,803 moving parts.
Despite these challenges, the benefits of having a keen awareness of economic trends as an entrepreneur are powerful and plentiful, impacting aspects like fundraising, leverage, growth, exit opportunities, and more.
In this piece, we dive into why a nuanced understanding of macroeconomics empowers founders and how to cultivate this awareness as a business leader.
The macroeconomic environment touches a number of important facets in the journey of a company:
For founders, being plugged into the macroeconomic dynamics and staying on top of the ebbs and flows of the interest rate environment could have a profound impact on their ability to raise capital, where that capital should come from, and at what valuation.
When interest rates are low, relatively safer investments such as loans or bonds offer minimal returns, incentivizing investors to seek higher rewards through riskier ventures such as startups. However, during periods of high interest rates, low-risk debt products offering 6-7% returns become more attractive. This shift significantly increases the return threshold for startups, and the overall appetite to invest in the space. To remain competitive, startup valuations may need to decrease, thereby boosting potential returns and making them more appealing relative to safer alternatives.
Founders who recognize these changes in investor risk tolerance can adapt their fundraising strategies accordingly. This will include adapting the size of the round, timing, valuation expectations, and choosing the right target audience.
As a founder, the ability to grow your business is directly correlated with the spending appetite of your audience, whether these are B2C or B2B, and their spending appetite is directly correlated to the overall economic environment.
In a challenging economic environment, when individuals and businesses are tightening their belts and cutting costs, the potential for rapid growth of your company diminishes, and vice versa in a growth environment, where consumer and CEO confidence if high, it is easier to drive growth forward.
Founders can proactively adjust their growth strategies, and growth targets according to the economic environment, and no less important, the economic outlook. This includes choosing the right pricing strategies, growth spend, team build-up, even capex spend, all with the view of ‘stepping on the peddle’ at the right moment
The more predictable the business, the easier it is to anticipate and plan ahead. Taking it to the extreme - once a company goes public, the ability to predict performance becomes paramount, sometimes even surpassing the importance of your company’s performance itself.
This is because even the slightest miss in projections can signal to investors a level of lack of control over the business, undermining investor confidence and the company's valuation.
For example, a microcosm of this plays out during board meetings: discussions on budgets and annual plans typically start with the macro-level, how management feels the broader economic trends may impact the company, and from there, how to prepare for it. The ability to navigate and control this will serve as the foundational layer for the follow-on discussion.
The ability to predict performance is also significant at the private phase - in terms of investor confidence and the ability to navigate different industry conditions - therefore, the earlier a founder invests in building the predictability muscles within the company, the better.
Companies who have their finger on the pulse of what economic environment they are playing have the foresight to exercise caution and avoid becoming overleveraged.
During periods of low interest rates, companies can access cheap capital through an array of lending sources like banks, institutional investors, or venture debt funds, making it sensible to leverage up the balance sheet with efficient (cheap) capital. But when interest rates rise, that equation changes meaningfully.
High debt levels combined with elevated interest rates can quickly become unsustainable. Deleveraging balance sheets at a time of a downturn can be very tricky and put the company in a tight corner. Founders' ability to have strategic foresight will allow them to plan ahead and navigate these varying economic landscapes.
The "window" for favorable exits is directly correlated with the shape of the economy. During economic expansion, companies tend to perform better, strategic buyers are more likely to take risks and buy or merge, markets welcome IPOs, etc. Conversely, downturns dampen appetites for M&A or public listings as risk aversion rises. Ignoring these factors can lead to missed opportunities or subpar exit valuations.
To master any subject, the first step is recognizing its importance and committing the necessary time.
From there, the path is straightforward: stay informed, delve into research, and engage with experts in economics, be it academia, banking, or related disciplines, all will help deepen knowledge and stay current.
Once you've gained understanding, focus on identifying signals, analyzing their impact on your organization, and seamlessly integrating these insights into your strategic plans for the next 3 to 5 years, with particular attention to your 12- to 14-month budgeting cycles.
Interest rates are elevated, inflation remains a concern in many regions, geopolitical tensions are high, and political uncertainty looms with upcoming elections in many major democracies.
During such periods of uncertainty, rather than pursuing growth across multiple geographies or customer segments, well-versed teams will calculate each move meticulously, whether acquiring new customers or entering new markets and monitor carefully to see results.
This precision extends to spending, especially in sales and marketing. The focus shifts to optimizing conversion rates and fine-tuning strategies around pricing, target audience, and customer acquisition. It's about turning the dial up or down with surgical precision, real-time, ramping up efforts in high-potential areas while scaling back in others.
By maintaining clear targets and remaining agile enough to adjust tactics, founders can navigate turbulent economic waters and strike that delicate balance between growth and resource management in an unpredictable climate.
It’s a lot, we know. But fear not, for we have created a ‘Macroeconomics Cheat Sheet for Founders” where we decode key trends, what they mean, why it matters, and where to track them in the most digestible way possible.
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Navigating the intricate dance between sound business planning, interest rates, valuations, and investor sentiment requires founders to be plugged into macroeconomic conditions from the early days. A holistic understanding of the economic environment enables founders to adjust pricing strategies, optimize operational efficiencies, and explore cost-saving measures to maintain profitability and competitiveness in all market conditions.