What you can expect from investors, and best practices learned from the last recession

By:  Carl Adams, Jeramy Lund & Meredith Shields at the Sorenson Impact Center and Foundation

We know we don’t have to tell you that over the last month, everything has changed. As a social entrepreneur trying to grow something new, innovative and game changing for the world, you probably feel like the proverbial rug has been pulled out from underneath you. Only a few months ago, you were kicking-off 2020 full of optimism with robust pipelines, new hiring plans, exciting sales forecasts and relatively free flowing capital. Yet now, many of you are finding yourselves parting with the employees you worked so hard to recruit and train, seeing hard won customers back out of purchase orders, and fighting for limited inventory in now slow moving supply chains. 

This period is painful for all of us, but it is not without opportunity and hope. As we’ve discussed with the entrepreneurs we partner with, it’s critical to remember that some of the most disruptive, game-changing companies that we all love today came out of, or were transformed for the better by, the 2008 recession. Recessions are not new; we can look to the 2008 and previous recessions for a play book of best practices as well as what we might be able to expect.

What You Can Expect from Investors and Why

  1. Funding will be harder to get, for a while. There are fewer investment dollars to go around, which means the bar is much higher for any investor who is willing to put capital to work right now. Right now, a lot of investors are basically “on hold”, waiting to see what happens and hesitant to fund anything. Looking at the last recession, from mid-2008 to mid-2010, overall venture funding fell by almost half and didn’t recover until 2011. Why? There are two main reasons. First, during a recession, investors know they will have trouble raising their next funds. As the market shrinks, funds have a harder time attracting new LPs, who have just seen their asset values plunge. Second, investors, like entrepreneurs, are also busy trying to figure out how to survive, which means supporting their portfolio companies as much as possible to keep them afloat. For many investors, this takes super priority over new investments. 
  2. Terms have changed dramatically and valuations are lower. “Market” terms from a month ago are not a starting point for a discussion with investors today – even your existing investors. Pricing risk appropriately means that your deal terms, including valuation, will likely be lower to reflect increased uncertainty. The hard truth is that down rounds will be common for a period of time as the market corrects. To get a deal done and get cash in the door, you’ll likely have to go out with a lower valuation than you had even a few months ago. Over the last few years, valuations grew exponentially as the market was on fire. Valuation is a function, not only of the merits of your business or ideas, but also of the market and availability of capital. For most companies, your customers, suppliers and even governments are all experiencing strain in ways that may impact your ability to operate, let alone grow; and that’s being factored into every valuation. 
  3. Your Cap Table May Feel Lopsided. Lower valuations and down rounds could present a challenging situation:  giving away a larger piece of your company than you are comfortable with. If you’re in this situation, we recommend simply raising less by cutting your burn rate. Easier said than done, we know. But hard decisions now can prevent catastrophe in the future. 
  4. Your path to break even is more important than ever. Given the uncertainty in the capital markets, investors can’t count on you being able to raise more money in the future, so they need to know you’re close to being able to last on your own. Companies that can be cash flow neutral and are raising growth capital will be viewed more favorably right now than those raising to fund continuing losses. The key question for every entrepreneur right now is “what does it take to get to break even?” For many, it will mean pulling back on high risk / high reward opportunities, or maybe growth overall. Again, we know this is painful, but it may be necessary in order to survive.
  5. Priced rounds may become more popular than convertible notes for now. A few months ago, investors were willing to delay the valuation discussion and fund investments with convertible notes. However, given the extremely high amount of uncertainty and risk in the market right now, investors are looking for priced rounds to give us comfort that our investment is reflecting the true nature of the current risk environment. Because of increased uncertainty around the economy and later round funding, they want to decrease the one risk we can control – valuation.  

Best Practices for Survival in a Recession

  1. Plan for mistakes and changes. If you’re an early stage start-up, odds are that your business may need to be able to withstand a strategy pivot, or other unforeseen disruption, that could put you effectively on hold. Your calculation of how much capital you need now should include enough buffer so that you can weather a few bad quarters. There is still a lot of uncertainty about what recovery looks like, how much of the economy comes back and how quickly. So, don’t let an unforeseen issue throw you into needing to raise “emergency capital” at the worst possible time. Contingency planning is a must.
  2. Look inside before going outside. Before you consider how much external financing to go after, we are guiding entrepreneurs to free up cash by cutting their burn rates as much as possible. Essentially, make every dollar stretch a little further. This was a practice followed by successful start-ups in the 2008 recession where we saw seed stage burn rates around $30,000 per month vs. the $100,000 per month average that has been more typical over the last 12 months pre-COVID. Where do you look for cuts? It’s painful, but here are some examples of where to look: put non-core offerings and/or initiatives on hold, put any unprofitable client relationships or products on hold (or renegotiating), assess vendor relationships and determine if you can absorb work internally with your existing team, and halting any enhancement work that’s not absolutely necessary (tech upgrades, research studies, trainings, expansion scouting etc). This is really, really hard (and painful); but sometimes it’s also required in order to survive.
  3. Explore alternative funding.  Try to find grants, SBA loans, other debt or revenue based financing options. Never applied for a grant before? There have been an inspiring number of organizations popping up to try and help companies, especially those trying to do good by their communities and employees. Duke University has put together a fabulous list of mostly non-dilutive capital resources for entrepreneurs at CovidCap.com.
  4. Use this time to understand your business better. The companies that survived the last recession emerged stronger than ever, in part because they were forced to pressure test each aspect of their businesses. This is a hard time to focus on growth, so make the most of your time by seeking to understand your business better overall and position yourself to grow smarter when the time comes:
    • What customers did you lose because of this?  Why?
    • What customers did you gain?  Why?
    • How are the communities you are trying to serve being impacted and how are you helping? Does your solution work in this environment? Are you serving people or communities in ways you didn’t expect? Could that be a new strategy for you? 
    • Which of your vendors really worked with you?  What did that teach you about them?  What can it teach you about how you should deal with your customers?
    • Which of your investors were supportive or disruptive, and what does that tell you about the types of partners you want to work with in the future?
    • Has your board been supportive and if not, do you need to rethink its composition? Now is a good time to evaluate how effective your advisors are.

And finally, here’s the silver lining:  now is your moment to be open and look for opportunity in surprising places. Nimble leaders who are able to seize opportunities and pivot when needed are the ones who not only survive, but can thrive coming out of this unprecedented time. This is also a time when change is inherent and expected, so if you were contemplating positive change anyway but were afraid to “rock the boat”, now may be your window. Whether it’s seizing new opportunities, or executing on things you’ve wanted to do for a while, make sure your organization is set up to find and act upon the opportunities you may be presented with. The world is changing rapidly – see if you can be one of the winners on the other side of that change.

Remember, there has never been a recession that we didn’t recover from. Hang in there. In these times, the companies that survive and strive are often those that are open to and can be adaptable on top of prudent and thrifty.