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Why Are Tech Startups Firing People Now?

Many tech startups (but not only them) are laying off people as part of their preparation for a “winter is coming” season in fundraising.

Last year, more than 107,000 jobs were slashed from public and private tech companies in the US, and this January the large tech corporate layoffs reached about 60,000 employees losing their jobs, with GoogleGOOG, MicrosoftMSFT, AmazonAMZN, Goldman Sachs, and Salesforce cutting thousands of employees.

Some of these layoffs are tied to the potential recession and the hardship of raising capital in the next year or two, which is realistic. But there is another major reason for it and it has to do with the 2020-2021 hunger for growth and the belief recruitment is a sign of it. This is while users, usage, retention, ARR, and revenues should be the right indicators for it, and recruitment a tool to serve them.

The obvious reason for the layoffs is the bearish market. Investors are now more conservative and don’t want to invest in high-risk ventures. In addition, the primary market is down significantly, nearly back to where it was three years ago, and obviously there are fewer IPOs’ expected in the near future.

If this case, private venture-backed companies will need a longer run rate before they can become public, which can happen in two ways, raising additional money or reducing expenses.

Raising additional funds is hard because investors are not keen to invest more and the result is lower valuations, which make it even harder to raise a lot of money. If you want to raise $50 million, then at $500 million you are diluted by about 10%. If the valuation is just $100 million, you will be diluted by a third.

The hunger for growth brought that about

But there is another very significant reason for the layoffs, that some of the startups have brought it upon themselves, or the recent investors have pushed them to do so.

During the 2020-2021 bullish market, many startups raised a lot of money at very high valuations, (sometimes overinflated), and with a promise of growth, the investors pushed them towards expanding. This includes the recruitment of large numbers of employees, to exhibit growth, justify the current valuations, and make the next round even at a higher one.

Now, growth should be estimated by real numbers. Users, usage, retention, ARR, and revenues – are the leading indicators for it. In many cases, it will be in hiring people who will enable growth. Essentially, it is considered investing in future growth.

The result was that when the focus was on growth, many companies were quick to hire, for two reasons:

  •  Invest to cultivate growth
  •  Satisfy the desire of the recent investors who only cared about growth.

Nowadays, when valuations are lower and IPOs are further down the road, the priorities are changing and most startups have a new priority – profitability, even at the cost of lower growth.

The result is layoffs for two reasons: when companies were at a growth blitz and hiring was the leading indicator to show the BoD or the recent investors that ‘we are doing the right thing’, some of those hirings were not the right fit for the organization. So, now is a perfect time to take care of that. In my mind, the right time to fire someone who doesn’t fit is within the first month after hiring, with no connection to the general growth or layoffs in the organization.

The second reason is the obvious one. While growth is the highest priority, we needed so many people to invest in it, but as soon as the priorities had changed and profitability is the highest one, these positions in many cases are no longer needed.

The result is unfortunately the same, laying off people.

The article was previously published on Forbes.

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