After seeing behemoth financial firms struggling to stay afloat, a startup seems like a relatively safe bet.  But don’t be fooled – new businesses are still the most fragile part of the economy.  The situation for startups is only more precarious given the mistakes of these once renowned financial institutions.  

We must quickly shift our focus from market domination to survival.  This economic crisis is going to result in a ton of startup road kill.   The eventual survivors will be in a great position to dominate their markets – if they continue to attract users and build great products while cutting their burn. 

Instead of racing to achieve critical mass at any cost, startups must now patiently work to eliminate marketing mistakes and waste.  In frothy times, conservative marketing execution can sometimes result in being overtaken by a more aggressive competitor.  Today you can forget about that competitor – they are racing toward their demise.  The more time you spend implementing metrics systems and optimizing conversion rates, the less you’ll waste when you eventually start spending money.  And many Web 2.0 companies have shown that it’s possible to achieve critical mass with little or no marketing spend. 

Unlike the first dotcom boom when traditional mass marketing was the norm for attracting users, web 2.0 entrepreneurs have been much more adept at leveraging the network to tightly track online marketing and even build user-get-user viral marketing programs.  Websites like Facebook and LinkedIn have grown almost entirely through address book scraping – because they built social invites into the overall product experience.  Other services like YouTube make user generated content so easy to share that many visitors are compelled to become free distributors of their content.  And we’ve only begun to scratch the surface of marketing tactics that leverage the network effects of the internet.  

Of course Web 2.0 marketing tactics can’t guarantee success.  Startups still need to create a product/service that people need and take the time to understand who needs it and why they need it.   They also need to be able to monetize it.  But with a massive user base, even micro monetization starts to become an interesting business.   Those startups that get these pieces right and combine them with efficient web 2.0 marketing execution will reach the level of excellence needed to rise out of the ashes of this recession. 

For months we’ve heard that startups should prepare for a recession that is looming in the future.  But it always appeared to be around some distant corner.  Well, it seems we’ve arrived.  Giga Om is reporting that Sequoia (considered by many to be the top VC) held an emergency meeting yesterday warning their portfolio companies to buckle down.    B rounds are already a wasteland – at least that’s the sentiment of the VC with whom I had coffee yesterday.  He claimed that money is still rolling into A round startups and that companies needing a C round often have solid financial metrics.  It’s the companies that are approaching a B round that are suffering.

So how can early stage startups weather the storm?

1. Raise as much money as possible on the A round.
2. Measure everything from day one.  Last week’s Startonomics conference has sessions on using a metrics driven approach to execute all the key parts of a startups.  Watch these videos .  Resources should only be invested into development and marketing initiatives that deliver measurable results.
3. As soon as you have raised your series A, figure out the financial performance you’ll need to be considered “a safe bet”.  The best time to raise money is when you are near cash flow positive and have identified several scalable positive ROI marketing programs.  If you need the money to fund these programs and reach your full growth potential – you’ll raise the money.  During frothy times you can raise money on hype; don’t count on hype valuations during a recession.

A recession is when the real entrepreneurs emerge.  Those who think it would be “neat to start a company” generally prefer the safety of a stable job during a recession.  LogMeIn was born in the last recession.  While we had a really hard time raising our $10m A round, twelve months later our $10m B round was much easier based on our proven metrics.   We then went on to build a company that now has its software on 50 million devices and is still on deck for an IPO.  Google also emerged during the last recession.  While the stock has suffered recently, it remains one of the most successful tech companies ever.

Each new startup I help take to market offers many potential rewards but there are risks too. 

The most obvious reward is the financial upside of equity in a successful company.  But there are less tangible benefits like the thrill of being part of a team realizing the potential of their vision.   Probably the most important long-term reward is that each startup success enhances my reputation and opens doors to additional startups with strong potential – while improving the skills I need to maximize these opportunities.  This allows me to continue doing the most enjoyable “job” of my life.

But the risks are very real.  A startup in a bad space with a bad product won’t be much fun to market – and I’ll probably fail.  And when the company flops, it will damage my reputation.  Enough damage to my reputation and I’ll have to figure out a new pursuit.  Of course most people recognize that it’s impossible to have a perfect startup record, but the opportunity cost of committing to the wrong startup means I won’t have the bandwidth to take on a potentially hot company.

Given these rewards and risks, I increasingly find myself evaluating opportunities with a VC-like diligence.  I’ve created an opportunity assessment worksheet that identifies key risks in the business. The standard format makes it easier to compare opportunities.  One of the biggest risks of any business is the inability to raise capital, so early on I set the requirement that I’ll only work with companies that have recently raised a series A or large seed round.  A very good VC can also help improve the odds, as they’ve achieved a better track record with their historical picks (and many would argue their “added value”).

Beyond general business risks, I obviously need to be confident that it is a marketable business and one on which I can make a meaningful impact.  The ideal category is what I refer to as a “disruptor” startup.  These are businesses that enter an existing category with a breakthrough feature or very disruptive pricing model.  My iterative, metrics driven marketing approach is perfect for helping these types of businesses discover their ideal market, differentiate appropriately and identify viable customer acquisition drivers.  Generally these businesses can get substantial traction just by harvesting the existing demand for the category.

Another startup category I often consider is what I call “innovator” startups.  These are much more challenging to take to market, but under certain conditions they are very marketable.  If they solve a specific important problem for a large addressable market and the potential customer lifetime value is high enough, it is generally possible to fund the full demand generation process.   Still, it takes a lot of time to discover the right target users.  Not only do they need to suffer from the problem, your product needs to effectively solve the problem.   Your next big problem is finding a profitable way to reach these target users and messaging they’ll respond to.  These are difficult go to market assignments, but they definitely improve my skills. 

For now I find myself alternating between these types of startups and avoiding those that don’t fall into these categories.