Weatherproofing your startup for any financial climate — the 3rd way
Last week the Economist drafted an article about the lack of financial tools governments have to deal with a recession should a ‘big one’ arrive. Similarly Ray Dalio (author of the best-selling book ‘Principles’ and a hedge fund manager) wrote a free to download PDF on the upcoming possible nature of a debt crisis in which he pinpoints a possible recession in 2020. With all this doom and gloom being predicted (and luckily with recovery as of the posting of this), if you’re in a fast growing company, it’s easy to get distracted and expect the worst, or try to ignore the noise and hope they are all wrong. There’s a 3rd way! It’s a very good time to get your house in order.
During my career, I’ve had the chance to witness two financially challenging times (the 2001 & 2008 bumps). In the first, I was in a startup (Baltimore Technologies) and in the second I was in a VC fund (Doughty Hanson). I can still remember the serial layoffs when I was at Baltimore Technologies as things started to come to a head. We went one after the other, in the order of the desks we had, to receive our separation packages. It was a sad day for many of us and it taught me quite a bit about how quickly things could turn around (I still remember chats with my colleagues regarding the value of our options only a few months prior and as the CEO promised much more growth and aggressive expansion).
During my time at Doughty Hanson, I experienced it from a different point of view as many of our companies — along with those of many other VCs — were going through the same challenges but, in both circumstances, I noticed a pattern started to emerge. Whilst not exhaustive, I did notice the following six attributes:
- Public companies stop buying external companies and start focusing on reducing costs internally.
- Because of #1 above, exit opportunities for companies that rely on external funding for growth or returns start drying up.
- As VCs start to focus their funds on rescue ‘bridge’ rounds for existing portfolio companies that are of high value, less money (to zero money) is directed to new investments.
- Massive failures in growth-sized startups start generating other massive failures as accounts payables aren’t paid and accounts receivables are received. The whole ‘chain’ so to speak, starts unravelling.
- With some failures being quite nasty, public perception then pushes for regulators to take action, which then drives audits and governance clampdowns in startups.
- Smaller funds start struggling as their portfolios that haven’t received enough funding to survive #3 above, so new investments start to dry up, and the whole early stage investing scene starts grinding to a halt.
If the above sounds scary, it’s because it is scary. However, many of the best companies were born or were chiselled out of tough times because of the actions and mindset the founders brought to the circumstances, and because some of the market dynamics also changed in their favour due to the downturn’s impact. Mark Roberge, the chief revenue officer of HubSpot, a Boston-based inbound marketing firm and Senior Lecturer at Harvard Business School, recently wrote a great piece on the opportunities that can surface in a downturn and that he experienced during his time. Read it here — A Recession Doesn’t Mean Your Startup Can’t Grow
So, a downturn can be good for you as well as bad for you, but what can you do today? In the words of a friend and current Venture Partner at Seedcamp, Stephen Allott “If you have the capital you can double down and beat the other players, and if you’re not lean & mean, you’ll either die, or get forced into being lean & mean.”
In that spirit, while not an exhaustive list, some of the actions below are actions that you could consider should we all find ourselves in that situation in the future. In a bull-market, some of these actions will seem contrary to what is being popularly proposed for massive and fast growth (usually expensive paid growth)! However, these actions should not be seen as ways being more ‘conservative/risk averse’ rather, they are about being more robust in your growth strategy, regardless of the market conditions!
These actions include:
- While the going is good, go for cash generative customers over vanity customers — there are customers and there are customers. Those that pay on time and have good solid financing are always going to trump those that are pie-in-the-sky opportunities, or who will flake on contracts due to their own situations failing.
- Lock-in contracts and get prepayments via discounts if you can — by focusing on getting cash-in-hand, even if at the cost of some discounts, you make sure you aren’t putting yourself in a position where a customer can flake on you later in the year if things get worse.
- Make sure you’re not overspending internally — hey, we are all suckers for great startup-merch and furniture but do you really need to spend that much on office perks and other cash-draining activities? Keeping things lean means you have fewer cash commitments and you also don’t have the issue of having employee morale drop massively as their previously indulgent massage Mondays perk gets removed.
- Focus on becoming cash-flow positive — at the end of the day, nothing beats being cash-flow positive, particularly if your customers are counter-cyclical or somewhat immune to the cycle (eg. govt services, larger cash-rich companies, etc). Short of that, focus on sustainable growth, not growth through crazy spend on customer acquisition.
- Make focusing on receivables management a top management focus — “lead from the top with questions like — have we been paid? what do we have to do to get paid? have we done it yet? who is accountable end to end for getting this customer to pay?” — Stephen Allott
- Raise as much cash as you can right now — nothing beats having cash on hand, so the more you can raise now, the better ‘reserved’ you will be for tough times ahead… that is assuming, of course, that you’re going for the appropriate use of this cash, not just a spend-quick mentality.
Ivan Farneti, an ex-colleague of mine at Doughty Hanson and now Founding Partner at Five Seasons Ventures (a food-tech focused venture fund) who had to navigate some of the portfolio issues of both previous downturns, had this to add — “Because of the length of this run, most of the founders in VC’s portfolios have not seen a downturn before. They may not be prepared, and knee-jerk reactions like cutting the online marketing budget and letting go of their community manager may be amongst some of the moves they make, but they may not be the right moves long term. Experienced board members should step in and add real value here (not just financial controls, but also how to deliver those cuts, but rather what communication style to use, how to manage it, etc). Additionally, founders may want to know where they stand in the priority stack of the portfolio of their investors, and may want to know how much reserves are left with their name written on them. Naturally, VCs might not want to share this with all of them, but this information could be important to help decide on alternatives when there may be still time.”
As mentioned before, some of the above recommendations might sound heretical to the current fashion of advice given to startups (which assumes a bull-market, fast spend, and cash-rich environment), but keep in mind that almost a decade ago, Bill Gurley wrote a great piece to his companies on how to weather that storm and Sequoia sent out a deck to their companies — and many of the same points that were made then are still valid today; there is a reason why great advice stands the test of time.