How startup should handle the recession?

How Startups Should Handle the Recession?

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The 2022 crisis is the third significant tech downturn of the internet era, following the dot-com bubble and the Great Startups in Recession.

Many experts are dispensing advice to founders on how to weather this storm. While this advice is broadly helpful, we must consider that it’s been approximately 14 years since the last major correction, and few in our industry have actively gone through a complete economic cycle. Therefore, it is essential to remember that good advice is tailored, specific, and, more importantly, contextual.

Each company is unique and faces diverse circumstances. Does a downturn affect every company identically? Yes, some companies have more favorable balance sheets than others. Are some companies able to raise funds even under challenging circumstances? Absolutely.

The best advice for handling the downturn should be based on the length of your runway and the efficiency of your business. Runway falls into one of three categories:

  • Two years or more.
  • Between one and two years.
  • A year or less.

Any early-stage startup will find it hard to keep afloat during a recession. As businesses cut costs, startups may find it harder to get deals inside the door due to budget cuts. This impacts the ability to raise subsequent rounds at a large scale. With the possibility of a recession looming, startups must start generating enough growth to reach a specific point of profitability. 

Back To The Basics

While the incoming recession may not be a cataclysmic event like the global financial crisis of 2008, there still looms a possibility of a prolonged economic slump and significantly higher interest rates. 

For tech startups to get back on track, the IPO market, which is currently trying to wait out the volatility, needs to come back. After the recent decline in the shares of listed startups, the wait for market sentiment to improve or to reduce the offered size has become the actual concern. 

If you look at the figures, Indian startups raised more than $2.7 Bn through mega anchor investments, pre-IPO rounds, and $7.36 Bn through IPOs in 2021. Yet, at the same time, there has hardly been any significant listing of tech startups on the stock exchanges in the first few months of 2022.

With the looming threat of a downturn, here are some golden policies that a business should adopt in times of financial crisis, which would help them keep afloat.

Recognizing the opportunities that are brought to light in times of crisis. Look at historically successful startups like Uber, Airbnb, and WhatsApp. You will find that period of crisis are not only a challenge but can also open up new avenues for entrepreneurship. 

Having a clear picture of your financial standing by assessing fixed and variable expenses and actual revenue is the need of the hour. Be mindful of short-term challenges and focus on survival’s essential essentials.

If the pandemic has shown CEOs and CFOs one thing, it was to free up cash and resources that would keep the doors open. Even when it comes to a recession, cash liquidity is imperative for keeping operations going. So, enable best practices for prudent cash and liquidity.

Create a narrative of change that highlights your company’s capability to develop new markets. It might mean challenging your business models to get a piece of the market share. This will help you showcase the value creation of your business to potential investors.

A reset in capital flows and valuations has enormous implications for startups. But, first, most companies need to recognize that the market is probably beyond the peak of cheap and plentiful capital. 

As unpopular as the opinion may be, founders today need to accept that the valuation metrics will continue changing. The comps from even a couple of months ago no longer hold validity. Scrutinizing expenses and the basics of entrepreneurial wisdom like lean startups, remaining profitable, etc., will start to hold again. 

After all, startups are not just about driving change; they must also successfully respond to change. Looking at the global financial scenario today, startups need to be prepared for bouts of economic turbulence to last.

Here are a few steps that startups need to follow in the case of recession or economic slowdown:

1. Cut costs and reduce redundancies

Zomato laid off 540 employees (10% of Zomato’s strength) from its customer support team to cut costs and reduce redundancies across its food delivery business. In March 2019, it was reported that the company lost INR25 on every successful order. There is also news that Zomato is trying to raise a $500 million round, but unfortunately, its existing investor Ant Financial is not interested in leading the round. 

Several Indian startups have taken the route of downsizing their team as a measure to reduce overhead costs and cut down business expenses. Startups fueled by VCs funding find it increasingly difficult to raise fresh funds. Those startups that somehow find investors will likely have to give up more equity and raise less money per round than in previous rounds. With India entering the economic slowdown phase, it’s natural for investors to become more risk-averse and invest in startups already operating in profit.

2. Clear off the debt

High-cost debt coincided with the global economic slowdown can significantly affect the ability to service the debt. So while Mukesh Ambani endorsed the government’s ambitious goal of making India a 5 trillion dollar economy during the 42nd Annual General Meeting of Reliance Industries Limited, his actions told a different tale. He presented the roadmap to becoming a zero-net-debt company in 18 months. 

This will be achieved through profits and selling a 20 percent stake in its oil and chemicals business to Saudi Aramco. So why is Mukesh Ambani hurrying to become a zero-net-debt company within the next 18 months? Perhaps, we can pick up some clues from the fact that economists have started raising their concern that a global recession may begin from Q3 2022.

3. Build cash reserves 

Conserving cash is the basis of financial management. Regardless of your finances related to your startup, it is prudent to plan for the rainy days and save some money. Holding off the business expansion plans is one way to build cash reserves. Another way is to set aside some cash your business generates as reserves and not use it unless needed. The startups that have prepared for the economic slowdown will win over those who have still not considered recession-proof their startup. Cash reserves will strengthen the ability of a startup to weather the storm and continue operating the business in case of unforeseen circumstances. For example, Elon Musk merged his startup x.com with Confinity to ride the tide of the dot-com boom without going bust. It’s a fact that many startups go out of business during a recession because they run out of capital. Having some form of a line of credit arranged beforehand will surely help them during a time of financial crisis.

Also Read: 5 Lessons Big Corporations Can Learn from Startups

4. Improve cash flow

A business can manage large receivables and little cash when things are good. But with a crippling economic slowdown ahead, startups need to look hard at ways to maintain a good cash flow for their business. Your startup will run successfully only if customers or debtors pay on time. You can think of ways such as giving incentives to encourage customers to pay on time. If unpaid invoices become a problem, you should consider invoice discounting.

Conclusion

This is not a very exhaustive list of what startups can do to become recession-proof, but it can be a good starting point. Every business is unique and, therefore, its challenges. The founders must identify factors impacting their bottom line and devise a plan of action. With funding scarce during the recession, the competition will also be less. This means it’s not the time to become recession-proof but also hyperactive and identify opportunities that can become game-changers for their business.

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