Economists are currently debating whether or not we are in a downturn. Most agree that if we are not there yet, it is coming.
High inflation and higher interest rates are putting a damper on spending from both consumers and businesses. With an economic downturn likely heading our way, early-stage startups should get out ahead of the game.
Technically, a recession is defined as two consecutive quarters of negative growth. In the first quarter of 2022, the U.S. economy shrank by 1.4%. We won’t officially know if we’re in a recession until July’s U.S. GDP numbers. However, the warning flags are everywhere.
Deutsche Bank forecasted a major recession back in April. Their economists stated, “We regard it… as highly likely that the Fed will have to step on the brakes even more firmly, and a deep recession will be needed to bring inflation to heel.”
The title of their report was, “Why the coming recession will be worse than expected.” Sheesh! Not exactly positive vibes coming from the analysts over at DB.
Whether the downturn is mild or major, early-stage startups need to take it seriously and start getting prepared now. You need to define your runway as accurately as possible and start looking for ways to extend it without raising a round.
The best course of action for you will depend on your unique scenario, but these are some actionable steps any founder can take right now to start digging in and getting prepared to weather the coming storm.
Table of Contents
- Make a Plan
- Look for Opportunities to Increase Cash
- Evaluate Your Funding Options
- Execute Your Plan
- Getting Help
Make a Plan
While we can’t predict the extent of a coming downturn, running different scenarios with your financial model can give you a pathway for bad, worse, and just plain awful financial scenarios.
To accomplish this and some of the other recommendations below, you need your financial model to be accurate and up-to-date. The biggest thing you can do to get control over the situation is to update your financial model immediately.
Build Impact Scenarios
Think about how a moderate downturn will impact your operating assumptions and start building scenarios to reflect those conditions. Start by plugging in lower growth rates and higher churn rates.
Start with your expectations for a moderate downturn, and gradually worsen your assumptions to create a worst-case scenario. There’s wisdom in the old saying, “Hope for the best and be prepared for the worst.”
Know Your Capital Requirements
Review the different scenarios you create and make a realistic assessment of your burn rate and the amount of runway you have right now. If you need capital, know how much you need and when you need it.
Create a Positive Scenario
Just because a recession is happening doesn’t necessarily mean you can’t get cash flow positive before you exhaust your runway. It might be harder than you originally thought it would be, but if your business had the potential to succeed before a recession, that potential is still there!
Build a scenario where your business gets cash flow positive. See what that scenario entails and start thinking about the actions you would need to take to get there.
You might shock yourself at how great you can manage this. And the experience will be at least as valuable as an MBA. You got this!
Look for Opportunities to Increase Cash
For an early-stage startup with limited runway, cash is the name of the game. There’s no shortage of strategies you can use to bring more cash into your business. Reexamine your strategies, look for opportunities to boost cash, and be creative.
Start with Pricing
Pricing is always tricky to get right, but a downturn is a great motivation to get yours figured out. In some cases, a slight increase in pricing can result in big cash flow gains.
One upside to the downturn is that a little price increase isn’t going to shock anyone when we’re all experiencing 8% plus inflation across the board.
Examine Your Payment Terms
Another option is to incentivize your customers to pay more upfront by providing discounts on annual subscriptions. It’s probably worth taking a small hit on total receivables to get the cash flowing faster.
Also, examine your payment terms with vendors. There might be some opportunity for you to increase available cash by changing your vendor payment terms to a monthly payment instead of paying an annual subscription upfront.
Look for Expenses to Cut
There are always some low-priority expenses that you can cut to lighten your load. Startups move at light speed, and along the way, they often end up with a few services or subscriptions that no one is managing or using.
Now’s the time to do a thorough review and cut anything that isn’t justifying its cost. Go through your income statement line by line and identify anything that isn’t extremely important. Review these with your team and cut what you can.
Also, review planned expenses and planned hires in your financial model. You might be able to prolong your runway by postponing future investments in infrastructure and people.
If you find that you need to cut existing people, you should start creating a plan for layoffs right away. Be sure to manage layoffs carefully, in such a way that your remaining people feel comfortable and secure, and remain committed to the company and its goals.
Evaluate Your Funding Options
Unfortunately, this is a very bad time to raise a round. If that’s what you need to do, know that it’s going to be a difficult process. But don’t give up hope. There are several good alternatives to raising a traditional VC round, and you should evaluate them carefully.
Know Your Runway
If you’ve updated your financial model as we recommended above, you should have a good understanding of what your current runway looks like. If you have less than 18 months, you should take action to extend it.
You might not need to raise a full round to make it through the downturn, but you might still need some additional funding. An extension from your current investors may be a great solution.
Your current investors are already familiar with you and your team, and they’ve already invested in your success.
Consider Convertible Notes and SAFEs
On a short timeline, it may make sense to look at simple solutions like convertible notes or SAFEs. These tend to come with lower legal fees and often include the ability to do a rolling close, which is ideal in uncertain times.
Be Flexible with Your Valuation
This one’s important. Valuation is always tricky, especially going into a financial downturn. Don’t focus on valuations from last year or even last month. The environment has changed drastically, and valuations will follow suit.
Execute Your Plan
Alright. Your financial model is accurate and up to date. You have a solid understanding of your cash flow situation and your options for raising funds. Now it’s go time.
Circulate Your Financial Model
Share your updated financial model, including the downturn scenarios, with your advisors, board members, and executives to get their buy-in. You want to make sure everyone is on the same page before you start making moves.
Start Raising Capital
If your plan requires you to raise more funds, you want to get started as soon as possible. Don’t wait until the height of the downturn when the fundraising environment is even more constrained.
At the height of the downturn, capital will be more expensive and slower to deploy. Rounds and valuations will likely be lower. It’s better to get moving now.
If it looks like an extension will suit your needs, approach your investors and board members now and talk to them about what it would take for them to put more funds into the business.
If you think a convertible note or SAFE is a better fit, start talking to your investors and working through the details. Use your financial model and your new scenarios to impress them with your forethought and preparation.
Let the Cost-Cutting Begin
Be proactive about cutting costs. You’ve already identified the areas where cuts can be made – begin executing on those now. Reach out to your vendors to renegotiate payment terms.
If you’ll make changes to your pricing or your customer payment terms, now’s the time to take action on those as well.
Communication is critical when you’re making big changes like these. You should have frank and earnest discussions with staff and stakeholders to share your plan and let them know what’s coming.
If you’re changing dates for planned hires or future infrastructure investments, make sure everyone knows the new schedule.
Transparency builds trust, unites your team, and lets everyone get prepared for what is ahead.
As a founder, you’re probably used to unexpected challenges. This one might feel like it’s out of your control, but you should respond to it the same as any other challenge that comes your way – tighten your belt, tuck your chin, and get started on the solution.
Your financial model is your primary tool to help you navigate this storm. You can use it to prepare, build a response plan, and communicate your response to staff, stakeholders, and investors.
If you’re an existing Forecastr customer, we have a lot of resources to help you:
- Blog Post: Why You Should Update Your Financial Model (and How To Do It)
- Forecastr Academy: Phase 5: Updating & Maintaining Your Model
- Office Hours: Every Tuesday (Refer to your monthly Customer Newsletter)
- Personalized Analyst Support: Just reach out to your analyst team today!
If you’re not a Forecastr customer, and you need a great financial model to help raise funds and navigate challenges like the coming downturn, reach out to us today for a free demo and consultation.