Sat. Jul 11th, 2020

Prudence and Perseverance6 min read

Keeping the fireplace burning through this time of tighter belts and slower dealmaking

Based on an interview with KrAsia, where excerpts were published in this article.

As the impact of COVID19 ripples throughout the startup ecosystem, investors, publications, and consulting firms are advising startups to buckle in this year. We wrote earlier this month about how business models can be built to withstand the harsh realities of our VUCA world. This piece tackles the overarching theme of prudence and preservation (company culture, cash, relationships) and when it comes to dealing with the difficulties in fundraising and exits during this period.

Not just a cash shock

While cash conservation is practical advice for any business during this time, startups in particular have to be more cautious as this is not just a cash shock, but a psychological/culture shock as well. We have seen a wave of startups dependent on heavy capital expenditure or subsidies — they will have to rethink their business model and the company culture.

This has also affected how startups operate and grow their teams. As markets undergo a dry spell, early fundraising and cash conversation are strategies that will affect not just the balance sheet, but the company culture as well. Founders need to take these effects into consideration.

Depending as well on the market the startup is in, founders may be more conditioned to adapt to this situation. Startups that have already been operating with tightened belts given the nature of their industry will be better prepared to adjust. Startups that have grown accustomed to spending heavily on marketing and hiring in the last year will feel the weight of the shock more than others.

Diagnosis and prescription

Dealing with these shocks begins with digging deep and fully understanding the financial and operational situation of the company for the next six months. Going through stress tests and scenario planning will help rationalize finances and operations moving forward. The key is to prioritize and focus on immediate and key expenses and core operations. In the balance sheet for example, items to look at and review would be large transactions, and renegotiate payment terms if possible. Another example would be hiring. Reviewing management team and hires during this period is not necessarily about cutting people off but perhaps realigning tasks and responsibilities, reducing costs for the team to operate efficiently (remote work), and even considering making essential hires while demand for jobs is high.

Once founders have a good idea of where they are financially and operationally across different scenarios, it’s important to honest and upfront with existing investors. At the same time, investors will want to see how founders manage this situation and display crisis leadership at this time. Founders that are able to make the necessary decisions early on in order to stay lean and nimble will be in a better position to ask for support from existing investors and even negotiate for potential deals in the next few months.

Keeping warm with cash in this capital winter

While there is pressure among startups to secure a warm supply of cash before the winter deepens, startups should still be strategic when it comes to investors. Founders should still align themselves with investors who can provide commensurate long-term value, and for the larger pockets, perhaps even participate in rounds down the road. 

Apart from equity, founders may need to look to other sources of financing. Bank financing may be effective in the short-term. Government funding may be in more supply depending on the initiatives in a particular country. Convertible notes in particular can be a beneficial choice early on if the business can safely expect a subsequent round in the works or accumulate enough follow-on interest.

However, as the current situation has rendered the next few months highly unpredictable, founders need to work under the assumption that it will be more difficult for investors to commit. Regardless of the approach, the situation calls for more strategic fundraising, rather than panic-raising and taking anyone’s cash.

Aside from external sources, startups may also see how renegotiating internal transactions (salaries) and transactions with suppliers or partners can free up cash. For example, some executives and management level positions are taking pay cuts or receiving their salary in shares instead. Focusing on internal sources of cash may be more effective in negotiating for external sources of cash down the road.

Keeping the relationships warm as the exits cool

When it comes to exits in a capital winter the pressure builds up on all parties to ensure that the exit will be a win-win situation. Founders need to be clear on what the exit means for them at this point in time in their company’s growth, if their expectations can be met by interested parties and if their market position likewise meets the expectations of buyers. From the buyer side belts are tightening but there is also the upside of making a valuable purchase at this time in markets that are receiving more business and consumer demand. 

Even though less exits can be expected this year, activity around them will likely remain high. After all, these deals are not overnight affairs and evolve over time. So even with the short-term uncertainty, building relationships and well-grounded confidence in potential buyers even through these conditions will be critical.

At the end of the day, if the company is on the path to profitability — making good gross margins on top of a sustainable business model — the opportunities for quality exits will come. To that end, founders will want to put themselves in a good position and maintain healthy financials and operations throughout this winter.

Technology emerging from the crisis

The current macro conditions will be a definitive moment for business models that have emerged over the past decade. Business models dependent on a regular supply of outside capital to scale will feel the strain more than those that have been designed to grow on the economics of their platform. The latter will prove to be more enduring, as we have seen with tech companies that have gone through several market cycles. For VCs in Southeast Asia, this is an opportunity to have more scrutiny when it comes to deals as business models are put to the test.

Even then, the current conditions will not necessarily mean tighter belts and slower growth for all sectors. If there’s anything the social adjustments taking place around the globe has proven, it’s that technology is critical to supporting business operations, day-to-day activities, and even supply chains straining under the stress of lockdowns and social distancing. Business support software like conferencing tools and online education platforms are in demand more than ever. Platforms that are able to digitalise supply chain transactions will see higher activity as people find more convenience in doing business online. This is an opportunity to drive more adoption and strengthen retention as people spend more time on the internet, and businesses and organizations migrate many of their processes online. 

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