Good times are over, plan for the worst: VCs warn start-ups

Good times are over, plan for the worst: VCs warn start-ups

The message from several VCs, both global and Indian, is to conserve cash, hire diligently, optimise cost, control cash burn, and extend runway as far as possible. 

(representational image) (representational image)

A growing number of global and domestic venture capital houses alike are warning their portfolios that the era of easy money has come to an end, the pandemic-induced digital boom is over, and that it is time to go back to business basics to survive. The message is to conserve cash, hire diligently, optimise cost, control cash burn, and extend runway as far as possible. 

Sequoia, known for its timely memos like “R.I.P Good Times” during the 2008 economic down and more recent one which called coronavirus a “Black Swan” event, has warned its investee firms that the current crisis is a "crucible moment" for the ecosystem. In a 52-deck presentation sent out to its portfolio companies, the storied investors said the global macro events including geopolitical crisis in Europe, changing monitory policies, soaring inflation across the globe, and the public market turmoil may cause a longer economic slowdown.  

“We expect the market downturn to impact consumer behavior, labor markets, supply chains and more. It will be a longer recovery and while we can’t predict how long, we can advise you on ways to prepare and get through to the other side,”  the Information reported, citing the presentation.

Sequoia, which has seen several cycles of economic upturns and downturns over its five decades of investing experience, said the cost of capital – both debt and equity – is rising that that necessitates start-ups to recalibrate their focus on to profits over growth. 

“We do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery like we saw at the outset of the pandemic,” Sequoia said in its presentation. 

Similarly, start-up accelerator Y Combinator sent out a letter titled ‘Economic Downturn’ to its founder community, advising them to prepare for the worst by slashing costs and extending runway immediately. 

“No one can predict how bad the economy will get, but things don’t look good.. The safe move is to plan for the worst. If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days,” the accelerator wrote. 

The accelerator reminded its founders of their responsibility to ensure that their companies survive without fresh external capital in the next 24 months. 

“If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan,” the letter said. 

Several other global investors, including SoftBank, General Catalyst, Coatue and Tiger Global are also showing restraints in their new investments as global funding environment is moving to a cautionary phase. Masayoshi Son, CEO of Japanese conglomerate SoftBank, had said recently the group may trim down its planned start-up investments by more than half.  

Back home in India, early-stage VCs Orios Venture Partners and Lightspeed Venture Partners have sounded out similar warnings to their portfolio companies.

Listing the global events behind the crisis including inflation, supply chain constraints due to pandemic, and Ukraine war, Orios said venture capital and IPO capital will be tight for possible the next 12 months. 

“In such times, cash is king,” Orios said and listed out the following rules to be followed to tide past the crisis: 

1. Become conservative with hiring. Take in only essential people and negotiate on salaries. This is important.

2. Push more levers to generate margins from sales. More margin is more cash.

3. Relook at your working capital, and try and bring it down through negotiations with sellers and buyers. Deepen statistical analysis to reduce inventory.

4. Consider borrowing. A good debt to equity ratio is always healthy, more so in these times when equity capital is constrained. Negotiate and shop around to get competitive interest rates.

5. Relook at your burn and find ways to optimize it. Can you reduce CAC, can you reduce fixed costs.

6. If you have termsheets from investors, don't hold out for better deals and close them asap. The next deal may be a worse deal or no deal at all.

7. Management paid over Rs. 60L a year should consider taking a part deferment in salary to send a message to the team of the times we are in. Make it everyone's business to cut costs and improve margins.

Lightspeed said the current market turmoil reminds of past corrections such as the financial crisis of 2008–2009, the dot-com bubble burst of 2000–2002, and the Black Monday crash of 1987. It has advised founders to rationalize headcount and refocus their company’s culture around performance, cut non-essential activities, and focus on the input metrics of good unit economics as a matter of survival. 

“While growth may slow in the near term, the good news is that future investors will not fault you for dialing back your ambitions temporarily to shore up the business. Those companies that use this time to strengthen their fundamentals will be rewarded by their customers and the financial markets in due time,” Lightspeed said in a blog post. 

Published on: May 26, 2022, 2:55 PM IST
Posted by: Aparna Banerjea, May 26, 2022, 2:52 PM IST