In the natural world, winter is the season when things don’t grow. Sunshine, rain, and other resources are limited. Those who are wise prepare for it by stocking up on essentials.
In the business world, a recession is the season when things do not grow. Just like in winter, resources are tight. Investors are less active. Surviving until times are better becomes the biggest challenge for many businesses.
As we enter the second half of 2022, we appear to be moving toward winter. Many are predicting that US businesses will soon be experiencing a recession. Some experts now are saying the risk of a recession is increasing. Others have called it “inevitable.”
In the startup world, founders are being warned to “plan for the worst” to give themselves a better chance of navigating the anticipated lean financial times. Y Combinator, which has been a highly successful Silicon Valley investment firm, told startups in a letter titled “Economic Downturn” that the chances of successfully raising money from investors over the next 6 to 12 months is “extremely low.” Y Combinator suggested that startups rethink plans they have for spending, runway, hiring, and funding based on the less-than-favorable financial forecast.
What should businesses do to prepare for the threat of a financial winter? We asked Jay Jung, founder and managing partner at Embarc Advisors, for his thoughts.
How can startups lengthen their runway to stay alive during the recession?
Jay: For most startups, a recession will mean cash stops coming in, or at leasts slows down considerably. So taking steps to preserve cash is an important shift to make. For businesses that are not already operating on a remote model, shifting to remote work can be a way to preserve cash by reducing or eliminating some fixed operating costs.
Remote work has also facilitated nearshoring. This is somewhat different from the offshore outsourcing trend of prior generations. As companies have embraced remote work, it quickly became clear that many roles could be executed by well-trained proficient staff in Latin America or the Caribbean for a fraction of the cost. The scope of nearshoring is broad ranging from customer service to app development.
Another way to keep spending under control is to utilize contractors instead of hiring full-time employees. While contractors may demand a higher hourly fee, they will save you in the area of benefits and taxes and make it easier to scale workloads up or down depending on what actually plays out in the next couple of months. High fixed cost can sink a ship during turbulent tides and flexibility may be worth the premium.
Are there certain tools that become more important in a recession?
Jay: Yes. And a budget is one of those tools. If you do not have a detailed monthly budget, now is the time to build one. Include all operating expenses, capital expenses, and one-time expenses that you are anticipating.
Once you get a budget established, perform regular variance analyses. If your anticipated revenue changes, your budget will also need to change.The goal should be making sure that you have available funds allocated in a way that allows you to accomplish the most important tasks.
A cash flow forecast is another tool that can be helpful in a recession. Carefully monitor cash flows on a weekly basis and use the data to do a 12-week cash flow forecast. You can anticipate revenue by tracking leading indicators such as your sales pipeline and bookings. If it appears that revenue could increase, start to think about the best way to invest it. However, if the forecast indicates a decrease, you should prepare to adjust the budget. Even if things are going well, it is prudent to prepare a budget-cut playbook that you can execute quickly when needed. A swift and decisive budget cut can help the company catch its footing before falling into what Sequoia Capital called the “Death Spiral.”
Are there any silver linings for startups in a recession?
Jay: Yes, but businesses will need to plan carefully to be able to take advantage of them. It is not uncommon during a recession for companies with great people and technology to run out of runway. This creates an opportunity for strategic acquisitions or mergers.
Companies who are in solid shape with a robust balance sheet can get ready to take advantage of these opportunities by revving up the corporate development engine. Create a wish list of the type of resources that would serve you best, then identify companies that could provide them. It does not hurt to proactively build relationships with businesses on your wish list so that you can have conversations about opportunities as early as possible.
Overall, it is important to remember that a forecast is a prediction. It may be based on expert opinions, but it is no guarantee. Being prepared, staying alert, and reacting to changing economic conditions will put you in the best position to be successful no matter what is on the horizon.
