Navigating the economic storm: Is the worst behind us?

Yes and no

Image by Karim & DALL-E

The past two weeks have seen a bit of a resurgence in public markets with the major indices up anywhere from 4% (Dow) to 7% (Nasdaq) in the month of November. This resurgence is mainly driven by signs that inflation is abating and that the Fed is done with raising interest rates. Whether this is true remains to be seen.

Source: Yahoo Finance

One of the questions I contemplate often is whether the macro environment is headed in the right direction, or more generally whether the worst is behind us. To help answer this question I looked at a few current and historical data trends, all in an attempt to prognosticate what the future holds. It’s the season to make predictions after all 🙂

Headcount trends (👍🏽)

The first data point I have is on headcount trends for a basket of startups that I have been following for several years. I have this annoying habit of collecting seemingly arbitrary data about some startups and have been doing that for a little over 2 years now. It’s my Monday morning breakfast routine. The data is compiled from public sources, nothing is proprietary. In the case of headcount trends, the data source is LinkedIn. I anonymized the companies I follow and instead label each by its sector and funding stage. The basket doesn’t include any of the very well known startups like Databricks, Stripe, but many are - scratch that, were, maybe still are - unicorns. 

The graph shows a couple of trends. First we can see the reduction in headcount that started in 2022 and continued through most of the year and into 2023. Recently, and admittedly it’s hard to see, we see a second trend and that is a stabilization of headcount with even a slight uptick, over the past few months. That’s a positive trend.

Glassdoor trends (👍🏽)

Glassdoor reviews are another data point I looked at. One caveat about Glassdoor, is that having very high scores doesn’t necessarily mean that the company is well functioning or is a good investment opportunity.

But, the data is still of interest and relevance. Below are the graphs of two companies from my basket. Once again we can see a steep drop in mid 2022 and a slow recovery since then. We are still far off from the heights, but at least the trend is positive. By the way, the same trends can be seen at almost all of the remaining companies in my basket. I omitted them for brevity.

Source: Glassdoor

Source: Glassdoor

The Fed (👍🏽👍🏽)

The Fed has an outsized impact on sentiment and the future of public and private companies alike. Predicting what the Fed does is not particularly a task I am good at. However, one can take a peek at prediction markets and see what the hivemind thinks. 

Source: Polymarket

Unicorns gored (👎🏽)

So far the story has been quite positive. Companies have stopped laying off and some have even increased their headcount. Employee sentiment is rebounding and the markets believe the Fed is done with increasing interest rates. But alas, this is where the story starts taking a bit of nose dive

The past two weeks have witnessed the abrupt shutdown of two unicorns. Convoy, a startup that last raised $260 million at a $3.8 billion valuation just 18 months ago is no more. Health AI startup Olive AI also shut down. Olive was once valued at $4 billion during the height of the digital health funding boom and last raised a whopping $400M. These two companies alone raised about $2B in total and are both gone.

I am sure there are other startups that shutdown recently and many more will over the next 12+ months. I had flagged this trend a few weeks back when I wrote:

One data point that the report highlights is that the number of startups shutting down at the b-series and beyond is also at record levels. I suspect that this trend will continue well in 2024, especially with later-stage startups. Many of those last raised money in 2021-2022 and would be approaching the point in which they need additional capital. Only some will be able to raise.

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Way, way too many players (👎🏽👎🏽👎🏽)

And now we come to the worst trend of them all. There’s just far too many startups in the $1B+ range. There simply isn’t enough liquidity or demand to fund all of these companies. Liquidity aside, the other more critical factor is just the sheer number of startups created during the ZIRP years of free money. Factor in the difficulty of an IPO, or even an M&A event, in the best of times and many of the companies below are faced with very difficult choices and an uncertain future.

Source: X and Battery Ventures

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Overall, the data is a mixed bag. Some trends are quite positive, the Fed being the more critical one, and others pointing to a very challenging environment. That brings me to my hypothesis, or prediction if you will. The future will be bright for the very few that survive and are able to do so on the heels of strong business fundamentals across growth & profitability. Subsequently, I expect we will continue to witness more Convoy’s and Olive’s through all of 2024 and 2025 as well. Simply said, many of the logos in the chart above will disappear. My guess is about 50% will be gone over the next 2 years.

We already see this phenomena play out in the public markets (bold emphasis mine)

So how do we contrast their positive commentary, with largely neutral commentary from the rest of the software universe? Most likely Datadog is seeing trends more unique to their own business. As the market puts a greater emphasis on bundled platforms today vs point solutions, they appear to be an incremental winner of market share. Best of breed platforms (with more of a usage based model) will recover first (in terms of revenue growth recovery). Datadog appears to be in that bucket and recovering first. This doesn’t mean the rest of the software universe will follow suite.

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The irony of this situation is it illustrates the essence of capitalism, or more generally Schumpeter’s Creative Destruction in action The cycle of startups entering, disrupting, and sometimes failing contributes to the renewal and revitalization of the economy. It allows for the constant injection of new ideas, talent, and technologies into the business landscape. Each failure also increases the likelihood of the remaining startups to survive. The survivors will contend with one less competitor for talent, capital and customers.