How the CARES Act, SBA Loans, and crisis management can you help your startup
The COVID-19 crisis has disrupted economies around the world, causing extreme uncertainty for businesses of all sizes. The US government has announced a series of programs to help organizations stay afloat while the broader economy is largely shut down, but not all of those programs will be appropriate for startups to pursue.
To give our portfolio companies a view into the programs potentially available to them, as well as a high-level view of the economic impact of the global pandemic, we invited Dr. Randall Kroszner, Deputy Dean for Executive Programs at the University of Chicago’s Booth School of Business and former Governor of the Federal Reserve, to talk about what startups can expect during this crisis and to answer their questions.
As a member of the Fed during the last financial crisis, as well as a member of the President’s Council of Economic Advisers (CEA) from 2001 to 2003, Dr. Kroszner has had a front-row seat to the kinds of government response that can be deployed to ease market volatility and attempt to repair financial systems threatened by global economic shocks. His research interests also include international financial crises, such as the Great Depression, and the lessons that can be learned from them.
Below are some of the key takeaways from his talk and answers to participants’ questions.
There is substantial aid for SMBs
According to Dr. Kroszner, there has been a lot of focus, both by the Federal Reserve and by the Treasury and the Congress, on small- and medium-sized enterprises. He went on to point out that it’s an important contrast to a decade ago, where the focus was on trying to keep the financial system from melting down and resources were perceived as going to Wall Street rather than to Main Street.
The paycheck protection policy, for example, was instituted to try to make sure that consumption doesn’t evaporate, and to ensure that small- and medium-sized enterprises continue functioning rather than going to bankruptcy or winding down.
There is also the SBA loan program, which is making available $350 billion to help small businesses disrupted by the pandemic to secure bridge loans to remain solvent. That program has received some criticism for early missteps in being able to deploy those loans, but Dr. Kroszner pointed out that the SBA last year gave out less than $30 billion in loans and is now trying to meet demand for 10 times that amount in one-twelfth of the time. And while that money is being deployed on a first-come, first-served basis to qualifying businesses, Dr. Kroszner was fairly optimistic that the funds will be replenished if need be.
Meanwhile, the Federal Reserve announced a Main Street lending program to provide additional support for small and mid-sized businesses, offering 4-year loans to companies employing up to 10,000 workers or with revenues of less than $2.5 billion. The principal and interest payments on those loans would be deferred for one year.
Be thoughtful about funding
While there are multiple programs startups and other small businesses can take advantage of, Dr. Kroszner cautioned that they need to take a hard look at their business and finances before deciding to apply. That’s because many of the government-offered financing options have strings attached, like requirements to make reasonable efforts to maintain payroll and retain workers.
“As you’re thinking about applying this type of funding… think about what your other sources of funding there are worth thinking about, whether you would be able to get further funding from your investors in more equity-type ways. Do you want to have the type of debt outstanding and are you willing to accept the strings attached about maintaining employment?” he said.
He went on to say that kind of risk management and scenario analysis can actually help companies to turn a crisis into an opportunity. For instance, you may be able to buy up some competitors or pick up something in the supply chain that is in trouble.
Be ready to talk to your investors
Typically, Silicon Valley investors expect their portfolio companies to be lean and agile, so startups aren’t always as well prepared to handle external shocks like the one facing us today.
As a result, Dr. Kroszner cautioned that founders will need to have a narrative and business plan ready to explain to their investors why they might want to apply for these government programs.
“Here’s a situation where these sorts of shocks have come in and you have to be able to make the business plan case to your investors that the traditional sort of financing structures don’t make sense right now,” he said.
Expect more market volatility
According to Dr. Kroszner, public stock market investors are struggling to understand the long-term impact of the Coronavirus and they’re reacting to small bits of data without having a solid foundation on which to make investment decisions.
They have taken some comfort in the ability of Republicans and Democrats to work together in getting the CARES Act passed, as well as central banks working together. However, he warned that when we get the GDP reports, we may never have seen the contraction of this order of magnitude within one quarter.
“Things were quite bad from 1929 to 1933 — GDP contracted by about 30 percent. But now we’re talking about contractions of activity of 30 percent within one quarter,” Dr. Kroszner noted.
“There’s going to be a lot of volatility and violent movements in the market going forward as people try to understand both the policy moves and the underlying impact of the virus.”
Valuations will come down across the board
Prior to the onset of the Coronavirus pandemic, most people had become accustomed to an environment where “everything is working perfectly and everyone assumes that all these startups are going to have all these great opportunities,” Dr. Kroszner said. “And investors are flush with cash and are just looking for good opportunities, making it very easy for entrepreneurs to get funding.”
As a result, both startups and investors became lax in their risk management. Even before Covid-19, there were signs that private-market valuations were declining, but he said the global pandemic will force people to think even more carefully about valuations going forward.
Dr. Kroszner cautioned that founders will need to think carefully about how they want to fund their companies, whether it’s through equity financing or through some of the available government programs.
“So you have to have a very clear explanation of what activities you are doing, what resources you’re going to need. And you need to think really carefully,” he said. ”But those equity valuations are definitely going to be coming down from where they were.”
Prepare for the long haul
Founders may have access to new types of funding in the intermediate term, but Dr. Kroszner said they also have to be prepared in the event that the economy doesn’t have the type of V-shaped recovery some people are hoping for.
Because demand projections are probably off and are going to have to be pushed off into the future, Dr. Kroszner suggested founders pay attention to their burn rate and make sure they have the resources they need and how that might affect the types of funding they seek.
“You have to think about that burn rate. You have to think about, do you want to maintain your employee base that would be required in order to get some of these loans or to get them, have them be forgiven,” he said. “It may seem great right now, but if you look at your plan over the next year, it may not make sense.”
Dr. Kroszner said founders need to think of this as a longer cycle and not to plan like the economy will rebound by August. He said many of the restrictions might be off by mid-summer, but they could end up coming back if there’s another cycle of infections.
“Hopefully, by the end of fall or beginning of winter, it could be sufficiently mitigated that a lot of the social distancing and travel restrictions will be down. But I think as a reasonable baseline, you should assume a pretty slow recovery for the rest of the year and then, a better recovery next year,” he said. “But you should also be prepared for a scenario where it’s extended, especially depending on the particular sector that you’re in.”
