Where Do We Go From Here?
Updated: May 19, 2020
Economic recessions occur every few years but the current situation resembles a perfect storm with the downturn coinciding with a global pandemic. However, every cloud has its silver lining, and according to Bain & Company, companies that survive recessions are those that can play a strong defence and offence, reining in costs while maintaining the momentum to reinvest in growth. Some of the key moves by companies that outperformed peers include early cost restructuring and balance sheet discipline.
How should entrepreneurs or business owners plan next steps? Should you act on it today? What should you do about it? Where do we go from here? To help entrepreneurs chart their company course through these difficult times, Endeavor continued its series of group mentoring sessions for its entrepreneur network. Here are some of our key takeaways on managing a business during a crisis.
1. Review Your Business Strategy
Balance Growth and Profitability
Rule of 40 - The Rule of 40 is where a company’s combined growth rate and profit margin should exceed 40%. In essence, the rule is used to assess the performance of any business units which focuses on two angles:
Growth: What you can realistically achieve in a given market
Profitability: A well-informed benchmark to be able to assess where you have operational opportunity to take cost out
Looking at these two dimensions, companies often have two options as achieving both growth and profitability simultaneously is mathematically impossible:
a rapid growth with near term losses before achieving profitability
maximising profit phase by ignoring growth rates and reducing sales and marketing expenses
The latter option is often ideal, especially during a recession as companies have to restructure growth plans to achieve better profit levels, with spare cash used to sustain the business.
Which Market Should I Focus On
Not all customers or markets are profitable for your business. This situation is best explained with a Whale Chart. List all your customers or markets that you are in and rank them according to profitability. Plot the cumulative profit against your customers, with the most profitable customers on your left, and least profitable customers on the right. The whale chart shows how much profit the first x number of customers generated, and how cumulative profit deteriorates after the peak.
Sometimes, in order to survive you will need to know which customers or markets you should prioritise. Some factors to consider when cutting out customers who are unprofitable are:
additional costs incurred to service the clients
clients who are bad paymasters, as the business needs cash today
consuming more resources than they pay for
creating tension between sales team and management team
Impact of Your Clients Going Out of Business
The Covid-19 has an impact on all your clients and unfortunately some will go out of business. One method to identify these clients is through the usage of a Rent Wheel. A Rent Wheel helps startups to prioritize and support clients who are good paymasters and have high credibility during hard times when receivables are harder to collect.
Some questions the Rent Wheel addresses are:
What is your client concentration, both by revenues and profitability?
Can we estimate the cancellation risk of each of your clients?
2. Cost Optimisation
Divide costs into two categories:
Strategic cost: Items that improve the bottom line such as cost of salespeople, advertising, and commercialised R&D
Non-strategic cost: Items to keep the business running e.g. admin, rent or real estate cost, consultant, lawyers, service operation, etc.
It is important to outspend the competition for strategic costs and cut non-strategic costs. Outspending your competitors on strategic costs requires intelligence and judgement. Distinguish expenditures that truly enhance your top and bottom lines from those that are wasteful and unlikely to pay off.
3. Cash is King
A company’s cash runway should act as a direct answer to whether the company undertakes an offensive or defensive strategy. For this section, we shall group companies into 3 different cash runway scenarios and lists of go-to strategy to overcome market downturn situations:
Less than 6 months of cash
6-12 months of cash
24+ months of cash
If you have less than 6 months of cash, here’s how you tackle it:
1. Cut your burn rate now!
Don’t wait or hope for the markets to turn; you should plan for the next year to be a very bumpy ride.
Stop looking at gross profit or EBITDA, focus on cash flow (by re-evaluating your working capital and expenditures).
2. Pay close attention to labour laws
Firstly, labour laws differ across countries, so speak to a lawyer.
If you need to reduce your workforce to ensure survival, have enough cash for severance & redundancy payments.
Have a conscience and be honest- try not to jeopardise your employer-employee relationship.
Transparent communication across the board.
3. Improve your cash position
If you’re in the middle of a fundraising process, recognise that it will be elongated as it is a higher risk in the current environment. Renegotiate the terms with the investors to offer a better deal for them to expedite the process. Or,
‘Hyphen’ Strategy: consider extending your previous round at substantially similar valuation and terms, to swap for an extended cash runway (e.g., “B-2”, “A-2”,etc.). This approach extends only fundraising duration of your last round without any change of valuation and terms.
For companies who were not initially fundraising, consider this bold option to get the cash you need for survival: Trade extra equity by taking a downround.
‘Live to Fight Another Day’ Strategy: Initiate a proposal for a down round by offering an expanded ESOP Plan together with vesting upon achieving a higher multiple of the new share price (e.g. 3-5x). Consider negotiating with existing investors to pump in more cash for the companies' survival. To sweeten the deal, renegotiate new or additional terms that could offer better valuation in the future when things got better (e.g. exits). Tie the company's fate with the investor's and trade them with extra share.
‘Survive’ Strategy: Many companies go through merger and acquisition cycles during bad times by consolidating with competitors within the same industry segments. How do you ensure that your company appears attractive to buyers?
In a nutshell, when business survival is at stake, exploring a strategic downround is the way forward. As painful as it may be, the reality is that a downround should not be avoided when it is required and justified. What needs to change is the attitude of both entrepreneurs and investors towards a downround.
If you have 6-12 months, here’s how you tackle it:
1. Reduce your cash burn to zero before you run out of cash.
2. Be obsessed about your receivables and think about your payables!
Pay close attention to your receivables; try to negotiate with your vendors on longer payment terms in exchange for volume or explore the option of a revolving credit facility, collateralised by something on your balance sheet or key cash-flow generating contracts.
3. If you try to raise, raise early with a better offer to investors!
4. To mitigate risk factors for investors, and if you are confident with delivering growth, give them a pro-rata option and play that card when you meet new investors.
5. To raise capital at a valuation higher than your last round, provide an IRR floor as a form of downside protection to the new investor. For example, using a convertible note structure, you can commit to a floor IRR of X% (e.g., 20%, 25%, 30%, etc.) using an adjustable conversion price. This is a very compelling structure and, if you can deliver a better IRR than that, you take on no additional dilution.
6. Merger or acquisition: How do you start consolidating?
Proactive Survive Strategy: consider merging with a competitor in the same space or acquisition by a larger industry player. Use consolidation to create value and take advantage of auctions and strengthen your market dominance.
If you have 24+ months of cash, here’s how you tackle it:
1. Industry procurement:
Consider driving discounts for your procurement by shortening payment terms. The main goal is to achieve a cost of capital that is below 35% a year, even for equity.
If you’re the exception in the market/industry that does well in this condition, turn your competitors’ misfortune to your advantage by hiring top talent.
o Who are the 10-best people in your industry that you can hire?
Be at the frontline of embracing the post-recession recovery
o Think about how the consumption pattern will change post-recession and how your product roadmap should adapt to the change
Besides creating a new product, consider blitzscaling by acquiring companies at an attractive price without going through the hassle to start over the process of product development cycle and product-market fit.
The case of “survival of the fittest” also applies to the business world. There will always be