The last time we faced an economic crisis, over 170,000 startups downed their shutters. Covid-19 has upended livelihoods and things will get tougher before they get better. Goldman Sachs expects the US Economy to contract by 3.8% in 2020 on an average annual basis, which throws up the big question – what should Founders and their investors do to prepare for the current crisis and navigate through the next few quarters?
Unless you are in the business of helping people fight and overcome Covid-19, you are going to see a drop in sales, see your supply chain disrupted, and see your capital sources dry up. As you adjust your startup strategy from growth mode to survival mode, these are the critical questions to answer:
- What will your sales and collections look like in the next few quarters?
- How capital-efficient are your operations and do you have enough cash to survive the current slowdown?
- How can you conserve cash without risking your future growth opportunities?
- To what extent can your current investors bridge you through the downturn?
These are the questions that we ask of our portfolio CEOs. Here is a guide to help you find the answers and mitigate risk.
Step One: Assess risk to revenue and cash from renewals and sales cycle time expansion. Identify emerging patterns.
The variable that has the greatest impact on your business is customer behavior. You should study the health of your customer base and the anticipated yield from your business development activities in the next two to three quarters. Your customers and prospects are also dealing with similar magnified risks to their businesses and will be thinking about ways to cap spending.
The following questions will provide critical inputs to your wartime business model:
- Pipeline Coverage: Is your coverage still 3X your next period’s target?
- Conversion Rate: Will your demo-to-sale conversion rate still hold?
- Sales Cycle Time: Will the time from demo-to-sale still hold?
Conversion rates and sales cycle times are lagging indicators and it is safe to assume that they will get worse.
Talk to existing customers who are up for renewal in the next few months to get a sense of their renewal plans and identify those who are at risk of churn. Talk to prospects at different stages in your funnel to understand if your sales cycle time will expand.
Keep a lookout for any emerging trends and patterns. Are you seeing increased churn from customers from within a specific segment or ticket size? This is likely if you have customers who now have an elevated business risk profile such as companies in the foodservice industry or brick and mortar retail.
Step Two: Identify and assess the what-ifs
Assuming you have a baseline model in place for 2020, you should model at least two different scenarios in preparation to build your plan:
- The Speed-bump Scenario: Renewals, new revenue, and collections estimates based on customer feedback and inputs. Maintain costs and any planned team and expense ramp up at the same clip as your baseline model.
- Tectonic Shift Scenario: Halve your renewal rate, double your sales cycle on new revenue, and delay collections estimates across all customers and prospects. Maintain costs and any planned team and expense ramp up at the same clip as your baseline model.
In both these scenarios, if your sales and customer success functions are relationship-based, then scale down any sales and onboarding team expansion where appropriate. Evaluate the following based on the two models:
- Net Burn and Cash Runway
- CAC Ratio
Benchmarking your performance on these metrics is a good exercise. Use our 2019 Companyon SaaS Benchmarking tool to see how you fare against your peers.
Step Three: Fundraising will be tough. Cash is King. Strategize for liquidity with your wartime model.
A drop in public markets is traditionally followed by a drop in valuation multiples for startups. Irrespective of whether angels and venture firms continue to invest in early-stage startups, the cost of capital in this period of uncertainty will be high. You will be looking at suppressed valuations and raising capital will lead to more dilution than is reflective of your business’s fair value. Either way, it is best to avoid a capital raise until the end of the year if you can.
Build your wartime model based on the two scenarios (see Step Two) with the overarching goal of reducing your net burn and extending your runway. Keep in mind that fundraising may take as long as six months from start to finish; a 12-15 month runway should keep you in the safe zone with fundraising efforts starting in Q1 2021.
Should you cut back on sales and marketing spending? With expanding sales cycles and uncertainty, monitor your CAC ratio. While a drop in the CAC ratio is expected, an acute dip in the ratio may indicate that you should scale back on sales and marketing payroll or expenses.
Discretionary marketing spend is typically lower than payroll and is beneficial as the recovery begins. Scaling back on sales reps can provide a larger saving opportunity.
Your funnel metrics should be closely monitored and if you are seeing worse off metrics, consider conserving this cash or redeploying this spend on customer success (discount on pricing to retain customers) to boost your renewal rates.
Make the hard decisions. Regardless of the analysis, now is a good time to have an objective look at your biggest cost head – payroll. Be honest about the 10-20% of your staff who you don’t really need. Before this downturn, we were in an extended upturn where companies typically hired ahead of the curve. Now that the curve has plummeted, it is inevitable that companies have too many on staff.
If the runway math does not support it, scale back or freeze hiring, evaluate restructuring pay packages, and tie them to revenue and collection metrics where possible.
Explore cost-saving opportunities. Evaluate your spending on software subscriptions and save on engineering expenses by deferring feature enhancements to a later period. Talk to your vendors to see if they can extend better credit terms. Delaying payments to large creditors who can afford delayed receipts is an opportunity that is often neglected. Rewarding customers for prepayment is a relatively inexpensive way to boost your cash reserves.
Step Four: Internalize, Communicate & Lead by Action
Times of crisis calls for an increased level of communication with your team, your investors, and your board.
But before going to the investors, there needs to be a clear demonstration of your willingness and ability to make the tough decisions under the assumption that things will get worse before they get better.
Involve the board and investors in what-if scenarios, it is in their interest to support you. In some cases, existing investors may not want to see a full retrenchment. They may even provide some liquidity to allow for cutting the fat and some meat, but not down to the bone.
Helping your team understand the impact on your business that you anticipate, your war-time business model, plan of action, and the new goals for this period create an environment of transparency, focus, and support that will help.
Questions? Feedback? Need Help? I can be reached at [email protected]
If you have other suggestions on what startups can do to weather this crisis, we’d love to hear from you. If you need help generating your scenarios or evaluating your wartime model, please reach out to us – we love rolling up our sleeves and doing some modeling work!
Stay positive & lead strong!