The survival rate of startups is very low in normal times. Let alone during a recession. In particular, early-stage startups. And make no mistake, the coronavirus pandemic will cause a global recession. And yet, if you take action now, make the required changes to your plans, and keep your team focused and engaged, your startup can survive it successfully.
So what should you do, as a startup CEO, to give your company the best chances to survive the coronavirus recession?
There are several vital imperatives that you need to focus on.
- Business Model
Cash is the oxygen of startup companies. When you run out of cash you go out business. As simple as that. Therefore, your #1 priority is to preserve your cash for as long as possible. How long is enough, you ask? Ideally, enough to last you 18 months of operation. In times of recession, I would say 24 months should be your goal.
Clearly, that’s hard to do in normal times. As we know, startups typically raise enough money to last them somewhere between 12-18 months. Hence, preserving cash during a recession requires a different approach and extreme measures.
Here are a few suggestions:
1. Calculate your real burn rate
First, calculate your current gross burn rate, that is how much cash are you spending each month. Divide it into fixed expenses (e.g. rent), and variable expenses (salaries, consultants, travel, AWS/Azure charges, supplies, etc.).
Next, take a look at your actual revenue each month – not forecast, but real revenue coming in each month. If you’re an early-stage company, that number may be zero.
Now, subtract your monthly gross burn rate from your monthly revenue to get your net burn rate. If you’re making more money than you’re spending, you are in good shape, for now at least. However, if you are an early-stage startup, most likely you have less revenue than your expenses, and that may get worst as the recession gets deeper and longer.
So, for worst-case planning purposes, I suggest you use your gross burn rate. Don’t assume all of your customers will continue paying through this crisis. Some of your customers will delay paying you; some will stop paying altogether.
Next, take a look at your bank account. Based on your calculated gross burn rate, see how many months your company can survive burning that amount of cash each month. This is your runway – the amount of time your company has before it runs out of money.
2. Reduce your burn rate
Now, you need to take action to reduce your burn rate as much as possible, while still being able to execute your current business model. You should assume that this recession will be longer than you expect. At this time, it’s likely to be at least 12 months before industries and markets return to normal. In some industries, it may take even longer.
So, here are several steps that you can take.
- Stop any low-priority activity and purchases. Be brutal. If it’s not critical for your core business, put it on hold, or cut it completely. This includes travel, some marketing activities, employee perks, capital spending (e.g. new PCs, phones, equipment), etc.
- Freeze new hires. Consider terminating all temporary employee contracts.
- Stop any consultant work that is not critical for the next 12 months.
- Where possible, restructure any monthly or annual payments to reduce monthly fees (perhaps by extending the contract). Contact your largest vendors (by spend amount) and see if they will be willing to offer you a longer agreement for lower monthly fees in 2020 and 2021.
- After three months, if the situation does not improve, consider asking all employees to take a pay cut. I suggest 20% for all regular employees and 40% for founders. Offer key employees more stock options to compensate for lost wages. In some cases, you can move some full-time employees to temporary part-time contracts.
- If this recession extends beyond 12 months, you may be forced to layoff people. You will need to prepare a list of people who are less critical to your company’s survival, or whose roles are no longer valuable. But layoffs should always be your last resort. Remember, if you survive this recession, you will need your people to grow your company. Laying off people too soon has a significant adverse effect on people’s morale, motivation, and trust. It also can tarnish your company’s reputation with regard to how it takes care of its people.
In addition, here are a few more suggestions from Sequoia Capital.
After cash, leadership is what is most needed in times of uncertainty. Your leadership will determine if and how your company will survive the coronavirus crisis. I’ve written about leadership in times of uncertainty in a previous post.
Having been through several major crises before, I expect this one to be just as challenging. In times like these, people are concerned, stressed, and anxious. They want someone to lead them to safety. A leader they can trust.
You need to demonstrate that you know what needs to be done in order to survive this crisis. At the same time, you need to be authentic and compassionate. Your people need to see that you understand their fears and concerns; that you truly understand the gravity of the situation and the risks it presents to them and the company.
Communication is key. You need to share your plans and emotions. Communicate often and in several forums and mediums: management team, all-hands meetings, one-on-one meetings, and informal conversations. Talk to your customers and your investors. The more the better. Make sure each employee knows what is the company’s imperatives, its goals, and what is her individual role in achieving it. Every employee must feel that they are critical to the company’s survival and success. And they need to hear it from you. Every employee needs to be committed to the plan.
Likewise, your customers need to feel that they can trust you to deliver and meet your commitments. That they can depend on you during these times of uncertainty.
Also, don’t try to go it alone. Involve your leadership team from day 1. Make it a team effort to come up with a survival plan. Make them feel that this is their plan, not yours. You need them to effectively lead their respective teams. Also, involve your investors. Let them know what actions you’re taking, and why. Review your plans and changes with them, and solicit their input and advice. Chances are some of them have been through a recession before and can help you get through this one.
Lastly, and most important, lead by example. If you are cutting employees’ salaries, cut yours first and by a larger percentage. If you are asking them to make any sacrifices, be the first to do it. Be accessible and responsive to them.
The way you treat your people in this time of crisis will determine their level of loyalty and commitment to you and your company. If you show compassion, sincere care for them, and lead by example, you will win their trust and loyalty for many years to come. Don’t forget, for your company to survive the coronavirus recession and thrive, you need your people. And you need them to be engaged and highly motivated.
It’s the nature of startup CEOs to be optimistic. And yet, you also need to be realistic and see the facts as they are. Hence, it’s important to review and test your business model assumptions. That’s true for normal times, let alone in times of crisis.
You need to test your assumptions about customers and revenue. For example, if you are selling to businesses, are their revenues in jeopardy? Is their industry experiencing a major downturn (such as the airline and travel industries)? Are your customers shutting down their operations for an extended period of time? Laying off people? If so, whatever revenue forecast and sales cycle estimates you had are no longer valid.
And, if you’re selling directly to consumers, their disposable income may be lower than before. They may also reduce spending during these times of uncertainty? Many are likely to lose their jobs. How would that affect your revenues?
Moreover, if people are confined to their homes for an extended period of time, how does this affect your channels of reaching them, selling to them, and servicing them? How does it impact your customer lifetime value, acquisition costs, etc?
Also, you need to check in with your key suppliers. They might also be experiencing significant difficulties. That can adversely affect their ability to provide you with the key supplies and services that you need in order to execute your business model and deliver value to your customers.
You and your management team need to continuously review your business model assumptions and see what if any changes are required. Changes could be minor, allowing you to maintain your business model as is. However, if the recession will be 12 months or longer, you may need to change your whole business model, starting with your value proposition.
One of the key elements of survival for startups is access to capital. And yet, investors, much like any other business or private individual, are also concerned about how this pandemic will affect their investments, funds, and portfolio companies. VC’s do their own crisis management planning, prioritizing their deals, and assessing the liquidity and risks of their investment funds. Their primary concern is the survival of their late-stage deals, which usually have the highest valuations. These startups typically have very high burn rates and funding for those can be very challenging. The survival of your startup may no longer be a priority for them.
Private investors (angels) and family offices may initially tighten their purse strings and freeze any investment deals, at least until there is more clarity about the extent and duration of this recession. Also, their personal wealth may have taken a huge hit. They may not have the same amount of capital to invest as they did before this pandemic. Therefore, if you are seeking to raise a pre-seed or seed round, you should expect it to take longer to raise that money. Moreover, the deals you will get will be for lower valuations than before this crisis.
We can look back at how the venture market behaved during and after the financial crisis of 2008 as a prediction of how it may likely behave this time around. Here is a good analysis of venture market during the 2008 financial crisis by Tomasz Tunguz. As we can learn from this data, seed rounds recovered early, but later stage funding collapsed and took years to recover.
Thus, startup CEOs need to assume that funding their companies will be very challenging during the coming 12-18 months, and perhaps even beyond that. So, in addition to reducing your burn rate, you need to prepare contingency plans for funding your operations. These can include using other forms of funding or accepting lesser deals in order to survive the coronavirus recession.
We are headed into a recession. It’s too soon to know how long will this crisis last. However, startup CEOs need to assume that it would take at least 12 months before markets recover, while some even predict that it could be longer than 18 months. You should expect this to be a very challenging and trying period to time. And yet, by taking timely and correct actions your startup can survive this recession. In times like this, I subscribe to the Stockdale Paradox.
But, you should act now. Plan for the worst-case scenario, communicate often and broadly and lead with compassion. This can be a defining moment (and experience) for you as a leader and for your startup.