A growing number of businesses, investors, consumers, employees, and members of the economy are concerned about the economic downturn that is occurring globally. Areas of concern vary between the political and trade conflict between the United States and China and the coronavirus outbreak. The latter bringing serious and increasing negative economic implications across the world. So, what does this mean specifically for venture capitalists, early stage investors, and technology startups? It is extremely difficult to predict a recession or how severe it will be, but we can take a look at historical economic behavior to extrapolate into current times.
Usually venture capitalists are comfortable with higher levels of risk. But to prepare for a downturn of uncertain length, they have begun to strategize with a focus on sustainable growth. With this in mind, founders need to be mindful of the following:
Does your startup have enough cash reserves for a rainy day?
All companies, no matter their level of advancement, should have contingency reserves for unforeseen eventualities. Some can be covered by insurance, equity providers, or operational top line. The reality is that it’s not the founder’s job to guess when the next recession could happen, but to be prepared for it. Founders should practice good cash management, have contingency plans, and choose investors with well-defined reserve policies.
Are the founders mindful of making the necessary business decisions during uncertain times?
Are the founders cutting unnecessary expenses? Extending cash runways? Expanding their customer base? Not relying on a single powerful client? Depending on a board of experienced directors that enables them as vision driven founders? Are the founders excellent communicators that transmit how the startup is solving a pressing societal problem? A founder needs to be prepared to make smart strategic decisions to keep their business alive.
Has your startup developed a financial viable business model?
Financial performance should be measured with primary KPIs like revenue and gross profit but also with greater granularity, such as revenue/dollar spent. Startups should focus on more reliable measures to understand what is really happening in the company. Many companies that enter the public market (through IPOs) have received major backlash from investors for their mismanagement. An infamous example is WeWork that ignored profitability to focus on aggressive growth strategies and compensated shareholders instead of devoting resources to important areas of the business that needed support.
Assuming that your company is a sustainable business with sane fundamentals, important barriers to entry, and scalability.
How much capital is available in the market during a recession?
Historically, it goes without saying that companies have found it challenging to fundraise in the middle of a recession. However, capital was still deployed even during the Great Recession. What changed was that investors became much more cautious. During a recession, funds may be blocked by their Limited Partners to make more commitments. They may even reduce the number of target deals, meaning VC Funds will tend to have more difficult investment criteria. It is important to note that some verticals, geographies, or industries will be more resilient, or may even be shown more interest than others in the middle of a recession caused by COVID-19. However, this does not mean that if your company is in a “hot” vertical like plant-based alternatives to animal products, or virtual conferencing, your fundraising will be guaranteed. No matter what the economic circumstances are, companies that have a market fit will always attract capital (be it equity, or clients).
Are the founders listening to their target market?
Economic recessions and recovery periods usually see changes in consumer’s purchasing behaviors, so companies need to make sure that they are listening to their customers and satisfying them. An example of a good measure of consumer satisfaction to keep in mind for B2C companies is the Net Promoter Score. Also, loyal clients that may not be able to purchase a service during the recession are more likely to come back when times become better.
According to Pitchbook: “General partners at VC firms may face increasing headwinds in the fundraising market. As asset values decline across the board, many LPs are expected to shy away from VC and other alternative investments as they rebalance their asset-allocation models. If a recession proves long-lasting, managers of all sizes would likely struggle to raise new funds.”
I urge technology startups to prepare for diminished access to capital, try to achieve break-even more than they ever have before, and seek non-dilutive capital sources such as grants for R&D, go to market strategies, or those that have been created to alleviate COVID-19’s economic effects. Non-dilutive capital has the advantage of ensuring that vision driven founders can own their destiny for longer. Finally, whenever possible, always reach out to strategic investors with relevant and large networks who can provide support and drive technology startups to become category owning businesses.
The economic recession brought on by COVID-19 requires funds and startups to make thoughtful decisions on how to manage risk and seize opportunities. Startups must prepare to weather this downturn and benefit from it too. Look to secure outsized returns, capture new market opportunities, while helping build a better and more efficient society.