Compass1

The resilient startup II: Extending the cash runway

| Insights

Every recession is triggered by different causes, but the impact on businesses is always the same – a focus on survival and conservation of cash.

“Revenue is vanity, profit is sanity, but cash is king.”
—Unknown


We are in the midst of a severe recession of uncertain duration. Until there is more certainty about the future, it is imperative that all founders and CEOs focus on preservation and survival. Although we wish for things to be different, ensuring that you have a cash runway is the key to making it through this situation.

"Ensuring that you have a cash runway is the key to making it through this situation."

The need for immediate cash and interest-based negotiations became critical for me during the post-dot-com bust after 9/11. As a company Founder and CEO at Mformation Technologies (which was later acquired by Alcatel-Lucent), I had to keep our fledgling startup surviving in the depth of a recession. We had less than 12 months of cash, nascent revenues, and we were staring at either liquidation or a cram-down round – if we could find an investor.

My experiences navigating through the two previous recessions as an entrepreneur, as well as helping our portfolio companies navigate the current one, offer some advice for finding sources of cash that can help your companies survive now, and thrive when the recession ends.

Sources of cash

1. Draw down your line of credit

    If you have access to a credit line that can be collateralized against your revenues or assets, draw it down now. Move it into a liquid account that the bank cannot pull back from.

    Obviously, this may damage the banking relationship, and extra interest will eventually come due. However, these issues are fixable and worth trading for your survival. You won't be alone; some of the leading global companies have drawn down their lines of credit in the last few weeks.

    Source: Financial Times (https://www.ft.com/content/6b299c42-6c66-11ea-89df-41bea055720b)

    2. Delay your principal payments to banks and creditors

      If you do not have access to a line of credit, seek to delay the principal amortization. Silicon Valley Bank has demonstrated leadership in this area by preemptively assisting their venture debt borrowers to temporarily defer their scheduled loan principal payments for a period of six months. Ask your bank to show similar flexibility.

      Taking on additional debt should be a last resort, as it limits exit attractiveness, reduces financing options, and the associated covenants can kill your business.

      "Taking on additional debt should be a last resort, as it limits exit attractiveness, reduces financing options, and the associated covenants can kill your business."

      Be aware that banks do not want to take your company; they know that they will barely get a few cents on the dollar if they hold a fire sale in a recession. Creditors will work with you.

      3. Renegotiate your lease

        Defer your outstanding rent immediately and seek to renegotiate better terms in parallel. Be willing to move to a smaller office if needed. Cash-rich companies such as Nike are currently not paying rents, nor are 50% of small businesses in the USA.

        Most of us find it intimidating to approach our landlords for relief. However, landlords desperately want you to remain a tenant in a downturn. They know that they are at the bottom of the food chain in a bankruptcy. And they know that they will find it difficult to find a replacement tenant during a recession.

        4. Pay your suppliers selectively

          Some suppliers are essential to your business and must be paid if you are to survive. This includes public cloud providers, payroll processors, etc. Others, such as utilities, lawyers, and travel agents, can be deferred. Try to pay your smaller suppliers; they are facing a similar existential risk.

          Technology companies should immediately seek payment extensions from their public cloud providers. AWS, Azure, and Google have the exceptional balance sheets to provide forbearance to their smaller customers.

          "Technology companies should immediately seek payment extensions from their public cloud providers."

          One of our portfolio companies spent over $300K a month on public cloud services, and these costs did not come down with the drop in their revenues. Unfortunately, without constant access to the public cloud, the business was effectively dead. The company managed to get a 3-month credit (by threatening to migrate to an alternate cloud provider), and the experience made the CEO hasten the process of reducing their dependency on a single cloud provider.

          Our belief is that one of the outcomes of this recession will be a rapid shift to the containerization of software development and multi-cloud deployments to avoid dependency on a single public cloud provider.

          5. Aggressively collect from your customers

            The quality of your customer base becomes apparent in a downturn. Large and high-quality companies usually pay on time, but often abide by payment schedules. Try to offer these companies incentives for releasing cash early. It is gratifying to see some large enterprises such as Vodafone, which is accelerating payments to their smaller vendors.

            Cash-strapped customers struggle to pay. In return for delays in collections, change their future contracts to pre-pay rather than post-pay for services in the future.

            Alternatively, as one of our portfolio companies did, you can 'fire' unprofitable customers. A modest sacrifice in revenues is more than compensated for by improved retention among remaining customers and improved morale within the organization.

            If there is an ongoing fixed cost to serve a customer, and they are unwilling to pay, there might be no other option but to let them go.

            6. Retain your most valuable employees

              Letting employees go is always bad for morale, even if it's necessary. However, the survival of the organization must always be weighed over that of any individual. Unfortunately, many CEOs mishandle this delicate process and destroy the morale of the remaining employees.

              If you need to cut employee costs, here are some ideas that work well:

              • Furlough employees where possible, especially if you believe that employee is worth retaining. Having access to benefits is critical, especially in a pandemic.
              • Avoid 'death by a thousand cuts.' Cut deep now, and rehire aggressively when the market improves.
              • Retain the employees who make the difference. In technology companies, product innovation talent is what drives future value, and these employees are worth preserving. However, sales and marketing activities can be dramatically reduced to compensate for the lack of demand.
              "Many of our portfolio company CEOs are not taking any salaries or are taking larger pay cuts than their employees."
              • Share in the sacrifice. Many of our portfolio company CEOs are not taking any salaries or are taking larger pay cuts than their employees.

              7. Seek equity investment

              If equity is offered by existing or new investors, you need to take it. Instead of anchoring on the last round valuation, you must raise cash now on realistic but fair terms.

              "If equity is offered by existing or new investors, you need to take it."

              Unfortunately raising equity on short notice is likely to be very challenging. New investors cannot do the appropriate due diligence, and existing investors will need assurances that you have already executed the cost cuts and strategy adjustments that will enable you to recover from the downturn and succeed in the future.

              8. Contact your government

                You should aggressively apply for any government grants or loans that are available. However, there is no guarantee that you will get this capital. Only a small fraction of the US startups in our portfolio that applied for the first tranche of the Paycheck Protection Program (PPP) received any capital.

                It is also prudent to delay paying any outstanding government taxes until the company is on firmer footing. Fortunately, most countries are currently being generous with tax withholding.

                None of the measures discussed here are easy to execute. A recession is not pleasant, but every recession plants the seeds of its own recovery. Mediocre companies go out of business, companies in competitive industries consolidate, and capital becomes rational and is put to more productive use.

                For leaders who can extend their cash runway long enough to participate in the recovery, a much more rational market and opportunity await.

                Back to our story…we made many difficult decisions during the recession after 9/11. We cut 50% of our operating costs in 2002-2003. We laid off 30% of the staff and the rest of the team took a 25% pay cut. We negotiated a 50% reduction in our lease, in return for moving to a smaller space and extending our lease by a couple of years. With the exception of our telecom and hosting providers, we deferred payments to our suppliers for 3 months. Finally, we renewed our focus on our technology and building a differentiated software product.

                As we started showing signs of progress, our internal investors provided us with bridge financing for 6 months. Eventually, in 2004, we raised a modest equity round from a quality investor. Even though it was a down round, the investor cared about the team and we were able to re-up our remaining employees to 50-75% of their original equity. A couple of years later, we raised a significant growth round and our business was finally humming.

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