The Smarter Startup

The 3 C’s of Downturn Planning: Cash, Communication, Contingency

Two Burkland CFOs recently joined a special episode of Startup Success to share candid advice on preparing for a downturn.

This conversation is from an episode of Startup Success. In this special episode, Burkland’s Steve Lord, CFO Fintech Practice Lead, and Daniel Rosenbaum, Burkland Consulting CFO, give candid advice on preparing for a downturn with a reminder that this has happened before and companies made it through by taking the necessary actions.

The conversation is so helpful that we decided to include it in its entirety.

Steve: When you look at the founder landscape out there, there are an awful lot of the startup folks that we work with who have never been through a world where valuations are going to go down.

If anybody’s raised money in the last five years, they’ve only seen valuations ticking up or have founders that have never seen a ten-year treasury bond over 3% in their entire lives, or at least since they were small children. When you look back on old cycles that we’ve both been through before, we’re both a bit the longer in the tooth than a lot of our founders.

What do you think they need to be indexing right now for what might be coming in six or eight months?

Dan: I think it’s about contingency planning because there’s a huge amount of uncertainty around everything from on the market side and certainly on the funding side. So to me, if you’ve already said, “Hey, it’s around cash, the runway,” I think communication is critical. If you can talk more about that later, because there’s both inside and out.

Then, to keep the theme with the C’s, it would be around contingency planning. How do you preserve optionality as you look forward, to deal with the uncertainty?

Steve: And then, when you’re looking at those three Cs that you just mentioned. Contingency planning – these folks have been very plumbed toward growth, and grow at all costs. It’s very easy for folks like us to throw out “conserve cash”, but there’s a lot of nuance to that really.

You’re trying to balance either a pre-revenue company getting to revenue – which obviously changes the dynamic a little bit – or finding that middle line between trimming expenses enough to survive, but not so much that you compromise the business. Walk us through a little bit, what your experience has been with that sort of stuff, and the kind of analysis that a CEO should be working with their team on to preserve that optionality and understand that runway in this environment becomes really very important.

Dan: On the PNL, I think one of the first things to do is to understand where you have or might have leverage points. What I mean by leverage points is: What are the handful of items that if you had to extend things for six months or longer, where would you go to?

It’s not worth spending time to cut 5% from a cost that is almost immaterial. So what are those handful of items? And then try to understand what impact those things have on your timeline and your deliverables. And is it tied to delivering a major project? Is it tied to driving revenue, which perhaps your investors or prospective investors are going to be looking at?

If you cut that expense or trim it, is it a timing issue, and you can delay it for six months, or does it permanently limit what you can do?

Steve: So it’s almost like looking at it from, “What do we need?” versus “What do we want?” Right?

Dan: Yeah, I think so. If you miss an opportunity, is it gone forever because of a competitive landscape? Or, if you delay a launch or a trial or something that you’re doing, now you’ve added six months to your timeline, but maybe you’ve preserved some optionality, if there are specific things you’re waiting on. So trying to understand what those levers are is really important for a contingency plan.

Steve: Startups out there that are working with finance pros, lean on them. They are the ones that can help you give that data the right look. One thing I’ve also learned in years past when I’ve gone through this kind of thing is: Startups that are funded in good times tend to over-hire or at least have a hiring plan that is very aggressive.

So one thing I want to throw in there is to look at the timing of those new hires and see if there are ways to stretch that, particularly on engineering and development, because if you are revenue positive already then there are obviously other levers you might be able to pull or use that capital differently.

Maybe go deeper into the revenue side. I think the folks that are in particularly difficult straits when the economy turns hard like this are the pre-revenue folks that are still developing a product. They are looking to raise money again in the next six to 12 months.

Dan: Most times for these companies, I would guess that headcount is going to be the major driver of the costs. That the expense is in there. When you look at the headcount where you’re spending, where do you need to spend the headcount dollars now? And where could you potentially delay? Maybe that’s a good segue into the communication piece.

I think it’s really important to communicate with employees, to be truthful. If optimism is warranted, I think the fact that you’re trying to get out ahead of this is a good thing. Communicate that, because I think in the absence of that communication, employees can very quickly get worried about, “We’re going to have cuts,” or “We can’t survive for six months.”

I think it’s important to let people know why you’re doing what you’re doing. What does this mean for the company and its sustainability in an environment where there are going to be a lot more frayed nerves? And it may be appropriate, depending on the customer base, to have similar communications with certain customers. But the fact that you’re being proactive about this should be a positive.

It can be leveraged to benefit. I think one adage is, “In difficult times, key employees can always find other work, and you don’t want key folks leaving.” And so you need to communicate and make sure that you’re up-to-date and feeling as secure as you can.

Steve: Yeah. And then some of it hearkens back to the COVID crisis as well. When we were putting out some advice on what startups needed to do right then. It goes upward as well. Get in touch with your board. Maybe have more frequent board conversations, and let them know what you’re planning on doing. Show them the numbers and what you’re thinking. Typically for startup founders, those VCs are going to have a lot of experience with this kind of stuff. So use that. Use that experience and knowledge, and they will also know what other startups might be doing. Another big part of the communication is making sure that you’re very much in touch and transparent with your investors and your boards, just to tell them where you are.

Maybe we skate through this and everything’s great. But if you’re not, you better have some plans in place. Another old adage I had from years ago in this kind of environment is, “He who loses least wins the most.” There are some silver linings in some of this, if a startup operates the right way and is pretty, being careful and thoughtful in the decisions they make in the six months leading up to a downturn. A lot of times they come out the other end a lot better than their competitors. They can use that to gain. That sounds a little draconian, but they can gain market share because an awful lot of people will wait too long to make the decisions that they need to make.

Dan: It’s a really good point you made about the communication – proactive communication with the board, your key investors. The expectation of most of these board members or investors is going to be: You’re planning for this. You’re being proactive. My advice also would be don’t wait for board members or major investors to say, “Hey, what are your plans?”, “What are you doing?”, or “Oh, we’ll get back to you next week.”

Be proactive about it and say, “Hey, this is the way we’ve looked at it. We don’t have to have all the answers, but certainly, step one is saying we’re aware of this environment. Here are the steps we’re taking. And are certain levers where trade-offs are going to be difficult.” You want board buy-in if you’re delaying major projects or launches.

Steve: Right. In many cases with a really severe downturn, that may be the only source of capital that you have open to you under the conditions that you’re willing to live with. So if you come to them, as you said, and all you’ve got is a week’s worth of operating capital left, that’s not going to be a good conversation.

But if you’ve been briefing them and they know where you are, and they know you’re astutely trying to navigate this, it’s much more likely that they’ll defend the investment. They have a longer timeline in their mind than a lot of startups realize in that they have invested in you for an eight or ten-year timeline, so they very much want you to get through this. They’re going to start talking about extending the runway and making sure you can survive to get through the valley over to the other side.

Dan: By the way, I would just plug having written a blog on a supply chain. We’ve focused a lot on the P&L. There may be some opportunities on the balance sheet to also extend cash runway and look at things like working capital. So for companies that do have those sorts of assets, it is important to also look there.

Steve: For sure. That’s another good example of where the CEO of a startup should lean on their CFO, because that person will be able to run those numbers and give you that optionality and tell you where there may be capital available, and then work to go get it. It keeps the CEO from needing to be heads down on all that.

Quickly, I wanted to touch briefly on a thing I’ve also learned in prior cycles. What about the speed of action in this environment? How do you index making the sort of demarcation between deep and rapid steps and cuts? And what about cash conservation decisions versus dribbling them out here and there and letting the chips kind of fall?

What do you think about that?

Dan: My bias is on speed. And this is going to sound a little counterintuitive maybe, with the bias on speed. I think you want an understanding of how long you can delay critical decisions for the benefit of additional information. If you’re looking ahead and you say, “Gee, if I wait on this for another three months, and I’m not likely to get a lot of additional information and I’m sort of excluding big macro events”, because you could always say, “I’m going to wait for those.”

The other benefit or justification is if you’ve done a decent job of understanding the kind of optionality and what it means as far as a timeline or other things you may be delaying, most of those should be recoverable. You’re not stepping off a cliff on these things.

Steve: Right. And I’ve run into that as well, where the CEO doesn’t want to fire people. They don’t want to cut costs too far because they’re concerned about abandoning the growth trajectory that they sold the VCs on last year or two years ago. And there’s a real implicit bias there. We tend to cling to our assumptions that we entered into. I’ve seen that firsthand. If you’re going to cut, cut deep and cut quickly. Don’t do death by a thousand cuts, because you end up not getting anywhere. You freak everybody in the company out with one or two layoffs, and then you end up in the absolute worst situation and you have people who are walking out the door to go get a better job. Now you don’t have control over that scenario like you said.

Dan: Since we’ve plugged a couple of old adages, I’ll add one more, which is, “Hope is a hope is not a good strategy.” So if you are delaying making tough decisions, typically it’s because you hope things are going to get better or turn around. And if you find yourself thinking about that avenue to justify delaying a decision, that’s probably a sign. It’s a bad sign.

Steve: I think the CEOs have to re-index the way they think about things. If we do go into a severe downturn like that, the job of the CEO is to survive through to the other side and keep the core premise of the business intact. You can’t do that in half steps.

You have to be very crystal clear and have a very, very defined idea of what that’s going to look like. And just like in other worlds, people train for missions and things like that. They mean the time to do this is now, not while you’re in the middle of it.

So as you’re looking through from the business’s perspective, ask: What is my cash runway? How long can I live? If I make steps today, can I get to a place where the business is cashflow positive? Things like that are very important to be working on so that you do have that optionality you mentioned.

Dan: And what is the core strategy? What is the focus? Because if you’re going to make choices, you’ve got to make trade-offs. That means there are things that you are not going to do. You’re not going to spend money, or resources on – including where you direct the organizational energy. Whether it’s in certain markets or certain R&D projects, I think focus becomes an absolutely essential guide. These are the things that we’re not going to do right now. And it feels like you’re always giving up something, but that can be a trap.

Steve: Right. Very true. Very, very good point. I also feel like people who haven’t been through a couple of these don’t realize what it starts to feel like on the other side. Things tend to fall faster than they come back, in my experience. We’re all running around now. Everybody’s freaked out about the recession and all this, and that’s all fine.

And we’re going to end up pricing a lot of this stuff long before it actually starts showing up in the statistics. But in many cases, the climb out of it takes longer than it took us to get into that mentality. You have to be able to stay focused on the core premise and the strategy of the business. It’s easy to get caught up in this panic mode, and that’s not what you’re there for. You’re there to navigate and lead the business through a difficult time. Many of our CEOs have all of the tools at their disposal to be able to do that. They just have never seen one of these before. It’s useful to be able to give them a little bit of guidance. I still believe that cash is king. That’s going to get the business through whatever may lay ahead. And if you can walk that line between maintaining the business’s core premise and making those trade-offs, most of our startups will get through fine. And that is something worth holding onto.

This discussion comes from Burkland’s podcast series, Startup Success.