The global coronavirus pandemic has altered the operating environment for all businesses. Early stage start-ups are no exception. Investors, market leaders and policy makers all expect a material decline in demand in 2020, which is likely to create prolonged cash flow challenges for most businesses.
If you’re an executive or founder of an early-stage company, this may be your first downturn at the helm of an organization. To help your runway planning process be more effective, we’ve used this space to compile our years of experience and knowledge in one easy-to-access place for you. Our goal is to help you and your team identify meaningful operational improvements, extend your company’s runway and reach your next targeted milestone or fundraise/liquidity event.
Your cash flows and runway can roughly be viewed as:
(Cash In) – (Cash Out) = Cash Burn, and
(Bank Balance) / (Average Cash Burn) = Runway (typically months)
Based on this information, there are two ways to impact your runway – altering collections and/or disbursements. Here are a few ways to get there:
- Accelerate cash collections
- Cut costs (CoGS, OpEx, CapEx)
- Raise a new round of financing
- Unlock cash on the balance sheet
Accelerate cash collections
This may seem obvious, but in some cases may be overlooked. You may consider asking yourself the following questions:
- Can I accelerate my roadmap of sales to bring cash in the door sooner?
- Is there a new paid feature I can deploy sooner rather than later?
- Can I offer discounted payment terms to new customers in exchange for multiple months/years of cash up-front?
- Can I offer discounts to current customers to incent them to renew & pay their renewal invoice early?
The simple truth here is that payroll costs will be 80-95% of total expenses for a majority of early stage start-ups, and it can be difficult to find other ways for your startup to save money. While causing potential disruption in other areas of the company, making changes to payroll will almost undoubtedly have the biggest impact on cash flow — therefore this should be the first place that a founder or manager looks to quickly cut costs if a large reduction in burn is required.
Some options to trim down payroll expenses:
- The company could offer a stock plan in lieu of of salary for a period of time, which has the added benefit of future potential upside to holders of the stock. This may require board approval.
- Management and other employees could take a temporary haircut, while the company accrues deferred compensation which would be paid down when the company is in a stronger cash position.
- Alternatively, layoffs are also an option though these are last resort. It is undoubtedly a difficult decision and should be viewed in terms of its holistic impact on the business. Our recommendation would be to ensure that product, existing customers, and revenue production are not harmed in any of these payroll related actions to the extent possible.
Other areas startups can look to trim excess costs include:
- Software/other recurring expenses: recurring monthly expenses can add up quickly when looking at a longer-term runway plan.
- Travel: one-off travel expenses are often large-ticket expenses, and can potentially be avoided if not completely necessary. Likewise, many conferences for 2020 are already canceled, so be sure that your travel plans and burn expectations reflect that.
- Co-working space: If you are in a co-working space or have a flexible lease arrangement, there may be a possibility to exit the lease and potentially recover security. If you’re fully-remote, ask if your employees would be willing to help by temporarily suspending their office lease.
- Advertising and marketing: Reduce advertising, focus on the channels that work. If your company uses a multi-channel strategy, invest in your most efficient channels only.
- Royalties and Other Sales Payments: If your company pays a % of revenue to any 3rd-party entity or organization, try and speak to your point of contact about their collections of royalties, or other similar facilities, and see if they can be temporarily suspended.
Often, doing a line by line, vendor-level review in these scenarios will find every last dollar that can be cut.
Undertake a new round of financing
The first step is to understand your financial plan and ensure that you absolutely need to raise funding in 2020, as the companies that will face the most trouble are the ones planning an institutional round in the next 6-12 months.The fastest way to get more cash in the door is through a traditional fundraising, with the understanding that you’re likely to receive unfavorable investment terms when compared against recent deals.
Investors will expect more control, lower valuations, and other deal terms which could lead to a down-round. If you find your team needing emergency cash within the next quarter, here are some options:
- The most direct route to raise new funds would be to go to existing investors and seek out a bridge round or interim funding, if it is warranted. Venture debt may be preferable for Founders who don’t want to touch their cap table. Investors will be keeping their cash close in the current environment, so this could be challenging but is likely the easiest option.
- Another external option could be seeking out venture debt financing or an alternative financing facility that is based on revenue share, your accounts receivable, inventory position, or strong unit economics. This will also be a tough route in the current economic environment, but worth trying if current investors are concerned about risk. It is also worthwhile researching what state and federal crisis-funding relief may be available to your company.
- A final option, which is heavily dependent on how far along the funding path your company is, is trying to raise equity. If you go down/continue this route you should ensure that your shareholders are aware of your intent, assuming you haven’t started already. If you have started, be ready for divergent deal terms, a lot of scenario modeling, and some tough investor questions. Equity Investment terms have definitively shifted in investors’ favors given the macro-environment.
Unlock cash on the balance sheet
The last option, in Finance lingo, is ‘unlocking cash from the balance sheet.’ Essentially this means generating cash sooner than you would under ordinary business operations. If you can stay on top of this every month, this will result in an extension of your runway and a far deeper understanding of your business overall.
There are a few ways to do this:
- If there is an Accounts Receivable (AR) balance you could try to pull collections forward. This is hard to do in normal times, so may be doubly difficult at this point in time to directly pull forward revenues from the customer. If your company is app-based company for B2C, or a pure B2B, you may be able to secure funding from specialty AR financing companies, like LSQ.
- A less favorable option, but potentially the only option for operators, is to stop paying vendors and build an Accounts Payable (AP) balance – with the understanding and agreement that it will be paid down at a later point. Our advice is that this is a conversation and not a mystery to your vendors. You could also try to negotiate longer payment terms, break up one-time and recurring payments, or some combination of the two. It is worth keeping in mind the potential risk to vendor-business relations in a situation like this, especially when everyone needs cash.
- Last but not least, the company could try to negotiate the return of some prepaid expenses or security deposits that are being held or unused. This is unusual to see if the best of times, but given the macro-environment we’re in it may not be that uncommon of a request.
In trying times, these are just some of the options that exist for businesses of all scale and size. Every company is unique and these learnings come from years of experience and the wide portfolio that airCFO serves as a financial advisor, accountant and tax preparer to. Have questions or just want to chat about your options? Feel free to reach out!