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March 26th, 2020

ELEVATE PERSPECTIVE

Startup Financial Management for a Potential Downturn

By Ting Gootee, CFA, CAIA, Chief Investment Officer

Uncertainty is unsettling. If history is any indication, what we know for sure is that our society and our economy will come out of the current circumstances; what is unknown is how long such a recovery will take.

Macroeconomic uncertainties create cash flow challenges unique to venture-backable startups. That’s because many of them pursue a structured funding model – raise a round to carry out 12-18 months of execution towards company development milestones and then raise another round and rinse and repeat. Unlike companies with steady cash inflows from operating activities, venture-backed startups rely heavily on invested capital to sustain operations and drive growth. Any uncertainty or potential disruption in the capital markets like what we are experiencing now immediately puts startup sustainability into question.

Elevate Ventures started investing in 2012, not long after the 2008-2009 financial crisis. Most of us can still recall vividly many startups’ struggles to survive due to the sudden and dramatic decrease in capital availability. For the last couple of weeks, as soon as the public market index started to decline, we’ve had numerous conversations with other venture capital firms, portfolio companies, and prospective companies who are either preparing for a round or are actively fundraising. Most of these conversations revolve around the same themes: one, how are you and your team members doing (physical health and mental and emotional well-being); and, two, how are you managing your cash runway (company sustainability).

Below are a few cash runway extension ideas from our conversations. It is important to note that every company operates differently. These ideas are meant to be tactical suggestions and, if implemented, should be carried out with empathy, thoughtful messaging and integrity.

Working Capital Management
  • Be creative and brainstorm with your team to look for revenue opportunities that may not have existed previously and be ready to act fast. For instance, some of our companies are in the space of serving consumer-staple products and businesses and are able to mobilize resources quickly to capitalize on opportunities and/or make up for revenue short-falls from other targeted customers.
  • Consider incentivizing pre-payments by offering discounts to accelerate cash collections. Example: Amazon’s annual subscription is cheaper than the total of monthly subscriptions.
  • Talk to vendors about payment deferrals, even for just a month or two. Please do this with consideration of your vendors’ financial capability. Like you, many of your vendors are also working through their own financial management efforts and may not have the capabilities to absorb payment deferrals by a large set of customers. This is where an existing trust and a win-win solution would help.
Expense Management
  • Freeze hiring until you have more information on how your revenue will be impacted.
  • Take a good look at all your non-personnel expenses and trim as much as you can. The obvious ones are travel and entertainment to start with.
  • Postpone consideration of or action on non-essential projects and initiatives.
  • If you are already in a contract for trade-shows or other financial commitments that no longer make sense for your updated operating plan, do not hesitate to negotiate but do it with integrity, respect, and empathy.
  • Avoid entering into long-term financial commitments such as real estate leases for the time being, if you can.
  • On the personnel front, take immediate action on non-performing personnel. However, for any layoffs you have to make, consider reaching out to your network and making candidate referrals.
  • Consider moving some full-time roles to part-time or outsourced functions, to give yourself more flexibility.
  • Assess where the current opportunities are and do not be afraid to shift personnel into different roles in response. For instance, when sales and marketing activities are slowing down, is there a need to add to customer success?
  • Do not make significant changes to the compensation plan until you know how your company’s financial performance will be impacted.
  • For those companies which have very limited cash runway, founders and management are typically the first ones to take salary deferrals.
Fundraising to further improve your cash position
  • If you are in the midst of a round and have investor commitments, close it as soon as you can. Do not optimize for what you would typically try to in a normal fundraising environment. Now is not the time to get the best deal you can. It is about getting cash as fast as you can in your company.
  • If you are not currently raising a round, stress test your financial model, figure out how much cash you would need in a worst-case scenario, and start talking to your existing investors. Most likely, your board and your existing venture investors would have already talked to you about worst-case scenario planning because they want to know how much dry powder they will need to prepare for their portfolio companies. This is where transparent and realistic conversations are needed, not optimistic fundraising pitches. Keep in mind that your existing investors are in this with you. Make them your allies and get them on board with your worst-case scenario planning.
  • If you have an existing line of credit or venture debt in place, talk to your bankers and pull down as much cash as you can. That said, such cash is typically meant to address short-term working capital needs, not to be used for cash shortfalls in other areas. Carefully examine your ability to service such debt from future cash flow perspectives. Using debt to extend the entire company runway, without revenue and without equity capital infusion, usually presents severe challenges to your ability in raising future equity.
  • Look for public assistance and non-dilutive funding programs such as SBA lending and SBIR/STTR programs. Such programs can take a while to get cash due to either demand increase or program newness. Quite a few companies in Elevate Ventures’ portfolio are actively seeking guidance to make sure they are in the best position to qualify for these programs and many of them have already applied for consideration.

Amat victoria curam: victory loves preparation. Entrepreneurs and venture-backed companies are best positioned to weather storms because they have a knack to uncover untapped market opportunities and have the capabilities to muster resources and act fast. The Kauffman Foundation sponsored a 2009 study that found more than half of the companies on the 2009 Fortune 500 list were launched during a recession or bear market. Through ingenuity, persistence and careful planning, many startups will come out stronger than before and will truly be on a path to becoming the market leading companies of tomorrow. We are here with you.

 

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