Working with numerous portfolio and pipeline companies in the past few weeks has given me valuable insights into how companies and investors first reacted to the current crisis and then adjusted their medium-term strategies accordingly. In this blog post I will summarise my key learnings, dividing them into three sections:
- Economic Context
- Corona Action Plan for Businesses
- Fundraising in Times of Corona
I. Economic Context
Despite the impact of the Coronavirus on society, mainly people’s health and well-being, we now start to experience the economic impact: Companies fearing bankruptcy, volatile stock markets and increasing unemployment rates. The Financial Crisis (2008) was the last recession we experienced. It lasted for about 18 months. Looking back, it had large impacts on the global economy, however, it also led to more than 10 years of economic growth. Drawing conclusions from the Financial Crisis on the severity or length of the current crisis is difficult as the Corona-crisis is not an endogenous or “market-made” crisis.
Currently, we are facing a crisis that was caused by an exogenous shock – a global pandemic that nobody could have foreseen. This shock can translate into a recession when temporary revenue cuts and losses turn into long lasting financial distress for companies. As a reaction, companies would have to let go of employees, close stores or offices and cut other expenses, which leads to high unemployment rates, low purchasing power and, therefore, low economic activity. Whether this current crisis will turn into a recession or not remains yet to be seen and largely depends on how well companies can absorb the current losses, how effectively governments support companies in distress and how fast there will be a “solution to the shock” (e.g. treatment/vaccine to limit the harm of the Coronavirus).
Long story short: It will pass! Economic theory and historic data tell us that every recession is followed by an expansion phase. However, keep in mind that nobody knows how long it will take until economies recover from it and when/how soon we will experience growth again.
In the meantime, your goal should be to keep the impact on your company as low as possible and make it through the crisis! Continue to the next page and check out the Corona Action Plan for Businesses to learn more!
II. Corona Action Plan for Businesses
There are moments in life in which “wait-and-see” works, however, now is not one of them! Even though the first shock of this crisis has passed for most, you and your team could still get infected anytime, a complete shutdown of your business is possible and your company could get into severe financial distress (among other possible scenarios). Based on the experience of working with multiple companies in the past few weeks and valuable insights of (Venture Capital) investors that have seen companies going through different crises, we can conclude that a proactive approach is the right way to go to avoid major damages.
Step 1: Analyse Impacts on Your Business
In order to make it easier to assess the impact of this crisis on your company and derive actions from it, I recommend splitting the analysis into subsections. Some of those might be impacted more, however it is important to review all of them to make sure that you don’t forget anything. Keep in mind that this should be an analysis that you review and adjust frequently: In theory as things change, but given the dynamic changes we have seen in the past few weeks, I recommend reviewing the following points on a weekly basis.
1. Operations & Team: The goal is to stabilise your operations and team – over and over again!
- Comply with the most recent regulations of your local authority – no exceptions!
- Anticipate next steps and draw from experience from other companies/ regions!
- Plan and if necessary, execute organizational adaptations (e.g. working in shifts). Try to cover each function in your business with more than one person.
- Create work-from-home protocol and provide resources your team needs to be productive. Introduce virtual meetings instead of face-to-face. Explore which online tools your team prefers for calls and messaging.
- Communicate with your team more frequently and transparently. A daily team call is a good idea!
- Be mindful of your team members’ situation – they may be struggling!
2. Supply: Looking at the whole value chain
- Which suppliers are affected by the crisis and how? Are delivery times and/ or payment terms affected?
- Reach out to your suppliers and keep communications up – at least regular email exchange.
- If you haven’t done so, work on a detailed inventory to estimate your inventory runway.
- Identify alternative suppliers.
3. Revenue & Clients: Take a customer-centric view to defend your revenues against declines.
- Which clients/ sales channels will be affected by the crisis and how?
- How are your changes in operations and/ or supply affecting your sales?
- Shift all sales and marketing costs to optimize your demand by focusing on most relevant clients.
- Increase communications with clients: Let them know about any changes and how you are operating.
- Develop strategies to mitigate the downside risk including
- An updated pricing strategy (potentially segmented)
- Leveraging your sales pipeline and focus on most promising leads
- Accelerate new sales opportunities to diversify revenue streams
- Think outside the box and be part of the solution: How can you adapt to meet people’s current demands?
4. Expenses: How can you optimise your expenses to not get into red numbers without “cutting the muscle”?
- Identify and cancel operationally-non-critical expenses such as trainings, travel and/ or consulting projects.
- Review and freeze hiring plans.
- Reach out to your landlord and discuss a potential reduction/ deferral of the rent.
- Optimize sales and marketing expenses.
- Postpone planned investments.
- If absolutely necessary, review current payroll and consider cutting salaries. Letting go of employees (if possible), closing offices/ stores/ routes.
5. Cash & Funding: This brings it all together as you are doing all of the above to avoid that your business is running out of cash.
- Frequently review cash balances and use cash forecasts (see Step 2)!
- Review Accounts Receivables and other current assets: How much money are you going to planning and when? Is there any “trapped cash” that you can collect? Is there a possibility that you cannot collect this money?
- Review current Accounts Payables: How much is due and when do you have to pay it? Optimize cash outflow by checking with suppliers on potentially extending payment periods.
- Review all other short- and long-term liabilities: Reach out to lenders and discuss your current situation. Ask about possibilities to defer interest and/ or principal payments.
- Update your funding pipeline and assess the likelihood of obtaining financing (if needed) – see section 3 for more info!
Step 2: Model Your Exposure – Stress P&L and Runway Estimation
If you know me, you won’t be surprised by this at all. In my work with both pipeline and portfolio companies, I spend a lot of time reviewing and updating financial models. While financial modelling might seem like a time consuming way of projecting something that will not come true anyways, if used right, they really are a powerful tool for financial/ cash planning and decision-making.
Financial model: Excel spreadsheet that includes a projected P&L, Balance Sheet and Cash Flow Statement for (ideally) +5 years. Ideally also includes historical data as a starting point. All projections should be assumption-based. The assumptions are used to calculate all business activities including revenues, costs, CAPEX, funding, etc. Ideally, calculations are made on a monthly basis. The runway of a company can be estimated based on the cash balance (to be included in the balance sheet): As long as the projected end balance of a respective month is positive, the company is not running out of cash:
- Beginning Balance = Current cash balance from bank statement
- Plus all cash inflows: Revenue, cash collection from accounts receivable, new funding
- Minus all cash outflows: Costs of Goods Sold, overhead expenses, interest and tax payments, outstanding payments to suppliers (accounts payable), cash spent to increase your inventory, loan principal payments and dividends
- Ending Balance = Beginning Balance + all cash inflows – all cash outflows
Especially in times of crisis, it is extremely important to stay on top of your company’s cash planning. The last thing you want is to run out of cash! Therefore, make sure you review your assumptions, with special emphasis on the next 12-18 months. Playing with these numbers will help you get a sense for the impact of possible changes on your available cash. The information from Step 1 is critical as you should include it into the financial projections.
A couple of important thoughts:
- Revenue streams: Make sure you identify and separate different revenue streams: Different prices, COGS, and clients’ behaviour for different business lines, sales channels or products. While some may be hit extremely hard in these times, others may do ok or even grow (for example online sales or groceries).
- Assumptions: In order to make it easy to make changes to your financial projections, calculate all numbers based on assumptions. Ideally, you can include 2-3 scenarios of assumptions (“best case”, “base case” and “downside case”).
- Stress your P&L (“downside cases”): Run numbers based on extreme revenue cuts: 30% – 50% – 90% lower sales for 3-6 months at given overhead expenses.
- What does this do to your company’s expected cash balance?
- Under which circumstances could this be realistic? Include thoughts into your “base case”
- Compare your results and draw conclusions from different cases: Your “best case” may not look too bad and you have plenty of runway until you would reach your cash limit, but how likely is this scenario compared to the “downside cases”?
- Find middle ground in the “base case”.
- Make sure you write down your argumentation and logic. In case the situation changes, you can review these points and make changes accordingly.
- Don’t forget about the opportunities. Any recession leads to growth once it passes. Which opportunities do you see in the long-run?
III. Fundraising in times of Corona
Raising funds for your company is always a challenge: Defining an investment plan, the right amount and instrument, finding the right lender(s)/ investor(s) that believe in your company, going through due diligence processes, negotiating the terms and finally closing the deal. And when you think you’re finally done, reporting obligations start.
To make it even more challenging, times like the current crisis affect banks’ and investors’ behaviour and processes up to the point that funding can dry up completely during a recession!
A study from The Federal Reserve Bank of St. Louis (2016) showed that bank loan growth became negative during and after the Financial Crisis. Further, a study from The Work Foundation and Lancaster University (2013) showed that only 26% of all SMEs that requested a bank loan during 2007/08, were approved and received it. This gives you an idea on how banks and other lending institutions might react to this recession: reduce lending activity and therefore limit the exposure to new risks. Focus on the existing portfolio.
On the other hand of the financing spectrum there’s a large global Private Equity industry that has experienced many good years since the Financial Crisis. Nevertheless, industry experts expect a significant downturn in funding available as many institutional and private investors postpone investment decisions until the crisis has passed or at least until they have a better understanding of its implications.
Key considerations to keep in mind:
- Expect that some investors/ lenders will not make new investments or postpone decisions after the crisis has passed.
- Expect changes in processes, additional questions and overall, a longer due diligence process (no matter how long you have been engaging with an investor).
- Expect lower ticket sizes: Some investors will adjust their ticket sizes in order to limit their risks.
- Expect changes in other terms: Investment conditions will tend to be more conservative. For example:
- Lower valuation/ cap based on lower expected growth (for equity/ convertible note) i.e. higher ownership and decision making rights of investor
- Requirement of more collateral or equity based on higher default risk (for debt)
- Stricter covenants and more veto rights based on higher risks (for debt)
- Proactively keep your current and potential investors up to date:
- Frequently share business updates with key results and implications of Covid-19 to show that you are operational and on top of the situation (e.g. newsletter-style emails).
- Update and share financial model including your “Covid-19 Downside Cases” (with current investors and/ or investors you are in advanced due diligence with)
- Prepare and share/ present a detailed investors’ presentation. This should include more detailed results, financial projections and scenarios and any requests that you have for your investors: How can they be helpful, do you need funding and if so, when and how much?
- Depending on your country: Include crisis-related lending programs into your thoughts. These can be governmental or private programs that aim to support the local economy with liquidity. Application processes can be (relatively) quick and interest rates can be subsidised.
Now that the first shock of this crisis has passed, it is a good time to prepare your business for the next few months. As I said in the beginning of this blog post, nobody knows how long this crisis will be and if it will lead to a long-lasting recession. However, observing the past few weeks’ developments and having seen many companies’ first responses followed by their medium-term strategy changes, I strongly believe that both young and mature companies should thoroughly and frequently review the points mentioned on pages 2 and 3, while never keeping global developments and trends out of sight. Try to learn as much as possible from your peers, potentially from regions that have been affected earlier than yours. Making it through the crisis should be your top priority and all your decisions and actions should reflect it!
Investment Associate, Pomona Impact
My passion is to work with social businesses from across the globe and invest into them. With my blog The Social Business I want to expand my reach, share valuable insights and support even more entrepreneurs. Please feel free to send me any comments or questions!