Managing Cash: 9 Steps From The Best VCs To Avoid Bankruptcy
As the world braces for a brutal economic crisis in the wake of the COVID-19 pandemic, we thought we’d collect and analyze the best pieces of advice we could find on how startups should navigate these troubled waters.
We are zooming in on 12 solutions that are both tested and practical. They emanate from experienced VCs and serial Founders who’ve been there before.
This post will keep evolving as more examples and counter-examples are published. You can contribute by adding knowledge for our readers, who are mostly Startup Founders & Venture Capitalists.
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#1. Open Your Mind (And Your Ears)
One of the subtlest pieces of advice out there comes from Bill Gurley, a prominent partner at Silicon Valley darling firm Benchmark Capital. Although it would have been good to add “with relevant business experience”, the idea is nonetheless clear.
If someone older than you with business experience is giving you advice on navigating tough times please listen & don’t argue. Good judgement comes from experience that comes from bad judgment. They used to have the same perspective you do. That’s why they are trying to help.
— Bill Gurley (@bgurley) March 24, 2020
The objective here is not to blindly adopt any measures that more experienced people will tell you about (“Ok Boomer!”).
But Founders, especially young entrepreneurs who have no experience of past crises, should keep an open mind and consider options presented to them.
The classic fallback phrase: “It’s different this time” has done more harm than good in the past.
#2. Throw Away Your Current Financial Projections And Build Downgraded Sensitivity Cases
Most of you already binned your pre-COVID-19 bullish sales curves. If you haven’t, now is a good time to do it.
But what will replace them? How is it possible to do any kind of projections when no new business has been signed over the last couple of weeks — or even months, in some countries.
For Y Combinator partner Anu Hariharan, the uncertainty will cloud not only 2020, but also 2021.
2) Most management teams have no ability to predict earnings for 2020 and 2021. The plan you built in Q4 2019 no longer holds for most of them.
— Anu Hariharan (@anuhariharan) March 24, 2020
So why bother? The point to do the exercise is to build what is called sensitivity scenarios.
By making a limited number of assumptions vary, with different magnitude levels, Founders can build both a decision tree and prepare for drastic measures in advance.
The trick is to build projections for one, three, and six months — and keep updating them with real data.
Let’s Take An Example
You projected sales of $250,000 for the next month, which would then increase over the next semester, and hopefully cover part of your structural cash burn.
But you also have another scenario with half that revenue in Month 1, and remediation measures on costs to keep the company afloat.
At the end of the first month, your actual sales are $175,000, the half-way point of your two scenarios. You estimate that your current pipeline will not cover the difference with your base case of $250,000.
Now you know what magnitude of restrictions on costs you need to put in place because you already built downgraded scenarios.
Sensitivity analysis allows Founders to react faster to actual data.
🛠 We currently run 90-minute webinars on this issue and related ones to help Founders build projections in uncertain times (click below for more information.)
#3. Extend Your Runway Assuming No Funding Round For 12 Months
Although many VC firms still tout that they are “open for business”, assume that they are not. Especially early-stage ones, i.e., seed and Series A Investors.
VCs are likely to become more cautious and selective, and it will be some time before they resume writing checks in a meaningful way. Most experienced VCs have large portfolios of startups to take care of and are most probably assisting them in their fire-fighting efforts.
Surviving long enough to weather the crisis, or at least successfully raising money, will require operational excellence and productivity wonders.
There may be a silver lining here: if your company emerges from this crisis, it may well be in a better competitive position because many others will disappear.
#4. Focus On Cash
Now is not the time to worry about your margins or what the market will say if you heavily discount your star product.
Offer your clients rebates if they pay faster, use discounts to sign new ones, sell bundled offers for the price of one product. Do what it takes to get cash in quickly.
Reducing past due receivables should also be high on your list. Get your cash while your clients can pay.
Focusing on cash also means that you order your priorities based on the speed at which they convert into cash. A sizeable potential payout that necessitates substantial upfront investment is probably not a good idea.
One area to pay attention to is your marketing plan. You need to reassess your distribution channels in light of how your customers are adapting. With people at home all day, phoning or emailing may be more efficient than online search.
You need to focus on the campaign types with the highest ROI — spend money to make money, not to build a brand.
#5. Reduce Salary-Related Costs
The main expense for most early-stage startups is employees’ pay. For tech companies based in hot engineer hubs, these costs represent a large part of their cash burn.
Consequently, many startups, especially in the US, have already started laying off in droves.
It doesn’t have to be the first step, however.
Stopping hiring, negotiating salary reductions (if it is legally possible), and using furlough can help reduce your cash burn until you get a better picture.
Be Kind
One learning from past crises is that employees have long memories. They remember which firms behaved ethically during hard times, and which ones didn’t.
Regardless of reputation-related concerns, doing the right thing doesn’t have to be costly.
Extending healthcare coverage and option exercise periods, writing LinkedIn recommendations for your laid-off employees or connecting them with CEOs of companies doing well are examples of things you can do to help.
But Be Swift?
Another line of thought is to make layoffs deep and early, so that employee morale doesn’t suffer from multiple rounds of redundancies. The folks at VC firm NFX tell stories of how they had let go as much as one-third of their employees in previous businesses they had founded.
Preserving the product and engineering teams, and moving other talents to different tasks, are some of the advice they provide to not only weather the storm but hopefully emerge a winner from it.
#6. Don’t Take New Debt but Renegotiate Existing Lines
We read here and there advice on taking as much debt as you can. Venture capitalists are notoriously bad at understanding the implication of bank debt.
Many just see it as a way for startups to get non-dilutive cash, therefore not diluting the VC firm’s position either.
I still hear too many VCs tell all their portfolio companies without equivocation to take on as much debt as you can regardless of current business health. It’s the WRONG advice. Use it thoughtfully and responsibly.
— samir kaji (@Samirkaji) March 18, 2020
Anyone who’s been on the wrong side of LBOs during the 2008 crisis (we have) knows that debt can be treacherous.
One reason is that bankers don’t have much latitude in managing loans. If your company misses a couple of payments (especially the loan’s principal), the bank will most likely “accelerate” the debt and seize asset collateral or a share pledge.
Depending on how liquid your assets are, and how likely you are to survive in the long term, banks will probably first restructure the debt. They usually abandon part of it, provide a more extended schedule to repay what is left, and take a handsome fee to arrange the operation.
In some countries, banks even have to push your company into bankruptcy to avoid being sued. The borrower’s suppliers could indeed make the case that they would not have done business with the company, had they known it was not creditworthy.
#7. Take Care Of Yourself
The coming months will be stressful for most entrepreneurs, who will continuously walk on the brink of collapse.
But this stress will not be the kind of energy-fueling one many Founders are accustomed to. It’s a more destructive type, slowly gnawing away at your physiological and mental stability.
Techstars’ David Cohen recently issued a 10-point guide for startups, many of which are already mentioned here. The noticeable fact: the first four points are related to taking care of yourself and your people.
Brad Feld, one of Techstars’ co-founders, has been a voice on mental illness affecting entrepreneurs for years.Â
#8. Get Ready To Take Advantage Of Unique Opportunities
Despite the gloom, not every tech company is at risk.
Resilient or Counter-Cyclical Models
Some startups will find out they are resilient, which means they will suffer but survive because of features of their business model, or who their clients are. Companies serving large customers doing well (such as pharma, or food e-retailers) are likely to suffer less than those who don’t.
Another example of resiliency is SaaS startups that have a majority of their subscriptions paid for annually, and whose costs are small compared to their clients’ main expenses. If you license software for $90 per year to SMEs with $5-10 million in sales, you won’t have a 100% churn rate.
Startups with counter-cyclical business models do well even when business slows down (think online education) or offer products that are more in demand than ever, as Zoom illustrated.
A product or service that helps other companies save money in their operations is likely to thrive in this environment. Ditto for B2C offers that help people maintain purchasing power. Twitter VC is full of examples of successful tech startups born during the last crisis, Airbnb coming first — although they are not immune to a lockdown scenario, naturally.
That’s why Y Combinator is funding startups this summer as usual, even if the batch has to be partly or wholly remote. YC knows this from experience. Airbnb was in the winter 2009 batch.
— Paul Graham (@paulg) April 1, 2020
Groupon is another example of a counter-cyclical offer.
Poach Talent
These companies should seize the opportunity to recruit talented employees who are let go by their employers. Engineers and programmers, especially experts of AI and data science, were so much in demand these last few years that smaller companies couldn’t hire them.
Benchmark Capital’s Peter Fenton recalls that in 2003 and 2004, strong startups could hire talent that would probably not have joined them before the Internet Bubble burst, or at least not for the same compensation level.
Make Acquisitions or Strategic Partnerships
Crises are fertile ground for mergers and acquisitions because valuations tend to drop, there are fewer potential acquirers, and owners are often in a hurry to sell.
Experienced M&A players who are after long-term value creation (i.e., not hedge funds, vulture funds or corporate raiders) know they have to patiently wait a few months before they go on a shopping spree.
They then have a better view of the market dynamics, as well as the quality of assets they are purchasing. The weakest companies tend to fail quickly.
#9. One Last Piece Of Advice
In a recent podcast interview, Lean Startup guru Eric Ries urges Founders to “look themselves in the mirror” and question their values.
It may seem odd to talk about values in a blog post dedicated to cash-preservation measures.
Yet, it is a fundamental exercise to do, because your values will drive which of these actions you take, and to what degree.
Ries goes on saying that the way Founders handle this crisis will be remembered for years to come by their employees, partners, and investors — all of whom they may be in business with again, even if their startup goes bankrupt.
His advice: try to stay calm, so you can see what is the right thing to do, even if it means your business eventually fails.
