This year has brought a wave of layoffs across industries at some of Chicago’s top startups.

Since January, tech startups including Kapow, Avant, Raise, Insureon and Trunk Club (among others), announced layoffs ranging from 7 percent to nearly one-third of employees. And these are just the layoffs that made headlines.

Chicago isn’t alone in this trend–layoffs at Silicon Valley tech companies and startups have spiked as the investment hype has cooled. But what do layoffs mean in an emerging ecosystem like Chicago, where there are fewer companies for employees to jump between, and major tech companies are among the first startup successes out of the city?

Northwestern Kellogg School of Management professor Mohanbir Sawhney and University of Chicago Booth professor Ellen Rudnick shed some light on how to read a layoff announcement: when are startups truly laying off employees in order to grow, and what are red flags that indicate the startup is in a tailspin? They also weigh in on what the recent wave of layoffs means for Chicago’s ecosystem.

Why do startups lay off employees?

For startups, “it is impossible to eliminate risk,” Sawhney said. “You have to get the business model right, growth rate right, you have to get the competitive environment right. So forecasting the type of people and how many people you need is inherently infeasible.”

Mohan Sawhney
Mohanbir Sawhney (Courtesy of Northwestern)

He said there are two layoff scenarios that many startups face, but may not spell the end of a company. First, if a startup changes their business model–i.e. pivots–it’s likely they staffed for a different kind of startup than they’ve become. So if a startup goes from B2C to B2B, they might not need as much consumer-facing marketing or social media staff, and may instead decide to invest that money in direct sales.

“[If] there has been a lot of growth, at some point in a company’s evolution, it has to slow down and say ‘What’s our strategy, what’s our model going forward, and do we have the right skill sets in place?'” Rudnick added.

Second, layoffs can come when a startup hires for growth that doesn’t come, often seen in industries that have a sudden influx of competitors. This is often seen in industries that are considered “hot,” Sawhney said, such as on-demand and delivery.

“With all these uncertainties in view, you have to sometimes downsize, sometimes upsize…It’s just difficult to predict how many people and what skillset you’ll need,” said Sawhney.

“There is absolute truth when they say they have to reposition,” Rudnick said. “When you’re growing so rapidly, you hire a lot of people. As markets mature a little bit, you realize that you don’t need as many people to do the same thing.”

What are red flags when looking at startup layoffs?

There’s another startup layoff scenario that doesn’t bode as well: when a business isn’t performing, and layoffs are a way to cut costs to appease investors or stay afloat. If layoffs come close to a fundraising round, Sawhney said it can be a red flag, “because you know that it is linked to the ability to make payroll and the ability to make money.”

Ellen Rudnick
Ellen Rudnick (Courtesy of UChicago)

In especially hot industries, if you can’t attract the attention of investors, it can be harder to get capital to grow past your competitors, said Rudnick. “If you can’t grow the base business, you’re going to have to lay off people to maintain the business,” she said.

Similarly, she said it’s important to look at whether there is a larger slowdown in an industry overall. “Look not just at the company, but the industry they’re in,” she said. “Are there certain industry dynamics in place right now?”

When assessing individual companies, keep an eye on the news and announcement section of the company in question, said Sawhney, because “companies that do well generate buzz.” Also consider the type of personnel that are being laid off: sales and administrative are usually the first to go, so when a tech startup starts laying off its developers, it can indicate they’re no longer building product.

Also note the percent a startup is cutting–if they’re letting go a third or half of the staff, Sawhney cautions that “you got it so wrong that your ability to get it right is in question.”

What do recent layoffs mean for Chicago’s tech ecosystem?

No need to panic, Sawhney and Rudnick agreed.

“Frankly, I don’t think it is a huge warning signal,” said Rudnick. She said despite any perceived investment downturn, there’s still money flowing into Chicago (even from the coasts) and Chicago’s ecosystem tends to be more diverse, which helps if there’s ever major problems in one industry.

Sawhney said that he believes layoffs could come due to the fact that Chicago is a younger ecosystem, which means founders may have less experience. But beyond first time founders, he said it’s important to look at the “macrocycle.”

There was just way too much exuberance a year ago. This is a natural correction.

“If you look at what’s happening in Silicon Valley, unicorns are being cut down to size, valuations are falling,” he said. “There was just way too much exuberance a year ago. This is a natural correction.”

Sawhney and Rudnick both said startup layoffs will have less social impact because workers are likely to have more up-to-date skills that allow them to be more marketable for other jobs. Rudnick noted that unemployment has gone down in recent years. She’s more concerned when traditional companies lay off employees.

“More established companies have pretty defined business models, [so] then you worry more about the economy overall,” she said.