Plan B
For most startups, plan A is to raise outside capital to enable faster growth. Plan B is what happens if you can’t raise capital OR you have raised capital but faster growth is no longer possible. A change in the economy will impact plan A and founders should be prepared. The best way to prepare is a Plan B — a new budget that allows the business to survive slower or negative sales, without external funding.
The macro picture
The U.S. Treasury bond market is an indicator of economic growth, decline and stability. This market, in addition to inflation, can predict prices and general economic activity.
In a normal environment, longer maturity bonds have a higher yield to maturity than shorter-term bonds. When you look at long term and short term rates, it’s alarming to see curve inversions, where 10-year and 2-year are equal, or 10-year dips below 2-year. This situation has historically indicated economic slowdown and can send warnings of a pending recession. On Wednesday of this week, the rate on the benchmark 30-year Treasury bond sank to an all-time low.
“It’s been 50 years and 7 recessions with a perfect record,” Estrella says. “It’s impossible to be 100% sure about the future but I’d say the chances of a recession in the second half next year are pretty high.” Arturo Estrella is the economists who first saw the link between yield curves and recession.
On a global scale, negative yields, the trade war and politics continue to make matters even more unsettled. Consumers have started to pay attention to all of these issues, even if they don’t fully understand them — a looming recession, manufacturing and construction slowing down, inverted yield curve, the markets all over the place. Consumer sentiment can have a huge impact. When sentiment is going up, people are spending because they feel good about the future and the economy, but conversely, as sentiment drops, spending drops. As spending drops, companies follow, reinforcing the cycle until we reach a low point and the cycle starts again.
University of Michigan Consumer Sentiment
There is a political narrative that says Democrats are creating the economic mess, and encouraging a recession because it will hurt Trump’s re-election chances. We’ll continue to hear about a recession because it can be a fear-mongering communications strategy, on both sides of the aisle. That’s why signals like yield curves are so interesting. They can cut through the noise and show us what people are doing vs. what they are saying.
The link between slowing economic growth, fundraising and exits
Fundraising is never easy, but the number of traditional and corporate funds has risen sharply in the last five years. Those funds aren’t likely to simply disappear, but if their corporate headquarters and portfolio companies begin to struggle, two things are very likely to happen: (1) some of their capital will be used to buy their portfolio companies more runway (2) time that might have been spent evaluating new deals, will now be spent evaluating how best to support existing companies.
Ultimately, a downturn in the economy means M&A activity might slow down and companies might delay IPOs. If the markets don’t do well, HNWI and institutions will probably become less risky in their investments as well, so funds might have a harder time raising, and the cost of capital for startups will increase.
RIP Good Times…
Was the title of Sequoia’s 2008 presentation to portfolio companies. By this time, Sequoia had a lot of data points to suggest there was a real problem. Beyond wall street indicators, consumers were responding to worsening outlook. Quarter over quarter, consumer retail spending was down across multiple categories and with this slowing spending, budgets were being cut elsewhere, most noticeably advertising spending.
Economic cycles are not new, but they require a different set of startup strategies that are often quickly forgotten and then relearned too slowly. It’s well worth reading the whole deck, but the following slides outline specific actions in the face of rapidly slowing growth and tougher fundraising environments.
Cash is King
Sequoia’s main concern was how their portfolio might survive long enough to make it through the downturn, into another period of growth. A great way to think about this, is shifting priorities away from spending to grow, to focus on preserving cash.
Or put a bit differently, assuming new sales will take longer and existing customer might struggle to pay, you can expect your revenues to decline. And so you need to adjust your costs to ensure you can survive. But simply acting isn’t enough — to succeed, you need to act fast.
Survival of the Quickest
A lot of teams understand how to cut costs, but too many move too slowly. For example, if you burn needs to be at $150k from $300k, each month you delay, is costing you $150k. A gradual six or twelve month program of cuts easily amounts to $1m. But there is more.
Investors are likely going to be very selective about who they think is worth saving. Teams that act quickly, signal that they are not just aware of the new market realities, but willing to take the necessary actions to survive. That makes it easier for investors to lend their support if and when it’s required.
New Realities 2000, 2008, 2020?
Plan B
The goal of Plan B is to rapidly (30 days) get into a position to survive flat or declining sales without the need for outside funding for at least 12 months.
Cash flow positive ASAP — make sure your monthly expenses are covered by monthly revenues
- More focus — make sure you are only working on the essentials for product and engineering.
- Default alive — may not be enough because existing customers may churn and it’s going to take more to win new customers.
- Collect receivables — now is the time to step up collection efforts
- Negotiate payables — getting more time to pay is a lot like borrowing money, but it may be simpler to execute
12 months of runway — is a useful target to ensure you have time to execute and explore options like funding, M&A etc.
- Zero-based budgeting — it’s hard to make cuts to a current plan to reach a level of acceptable burn. Much better to start over and add in each expense until you reach an acceptable burn.
- Review salaries — decrease base salaries and look for more opportunities to reward performance.
- Discuss personal burn — base versus bonus trade-offs won’t be the same for everyone, so spend the time to work out flexible options (student loans, family obligations, etc. ).
Raise more venture capital — this will remain an option, but is likely to become more challenging
- Valuations will come down — revenue multiples in public markets will come down and this will immediately drive down private valuations.
- Investors will have less time for new investments — they’ll have to do more work to support existing portfolio companies, so this means slower processes and lower chances of successful closes.
Consider other capital sources — not that these will get easier, but they will expand options
- Lending criteria will tighten — like equity, you will have to work with more costly capital as things tighten and lenders adjust.
- Revenue-, Project-, Asset-based — will come with outside review of around specific areas of execution and this type of feedback and analysis may also prove helpful to benchmark how you’re executing.
- Look to alternative forms of capital that act like debt but provide the runway of venture capital. Some examples are lines of credit, revenue share agreements and project equity that puts the investor side-by-side with the startup
- Develop your credit-ability now. Take out a small loan to establish proof of your ability to pay
- Ignore grants at your peril — it’s a competitive advantage. There are more sources of capital from governments and not-for-profits that should be tapped or prepared for
Get feedback — ask investors and advisors for feedback
- Helps your existing investors prioritize — as things slow, they’re not going to be able to support their entire portfolio equally. Higher chance of survival means more likelihood of ongoing support
- Feedback — this is new for lots of folks, so use the opportunity to get feedback on your Plan B
Startups of all stages should plan and establish a Plan B, but it is especially the earliest stage companies who should be ready with a contingency plan if the recession hits. In building out a Plan B, you win twice — you are ready when the slowdown arrives and you can see a different path to continue building with less cash.
