Business owners frequently panic as a downturn hits, and the responses tend to be scattershot. Panic pushes action. Executives reach for levers such as layoffs or price cuts, which may prove to be short-term fixes with lasting consequences.
In practical terms, downturns never last indefinitely, but predicting the length and the severity of a downturn is a tricky exercise. At my company, we produced two scenarios in response to the Covid-19 crisis: The crisis lasts for three months, or the crisis lasts for over a year. We put all of the key assumptions at the front page of our spreadsheets: duration, percent impact on sales and new expenses incurred by changing sales channels.
Scenario analysis helped us understand how severe the impact would be and how long we could sustain at current levels of operation. Scenario analysis then leads to sensitivity analysis: What does a 30% drop in sales look like, and are we even profitable at those levels? Do we need to apply the 80/20 rule and focus primarily on the 20% of business that is generating 80% of our revenue? What does supporting the highly profitable segment take, and can we sustain that level of support for three months? For a year?
The sensitivity analysis often reveals that across the board, price cuts and layoffs are too much of a knee-jerk reaction and can permanently impair a business. If the downturn is short, you might need more of a scalpel than a buzz saw. Once the scope of the impact is identified, there are a few tools you can employ:
1. Think about renegotiating everything. Nothing is off the table. We were able to push our rent down 15% temporarily, order smaller batches of supplies for rates that are normally reserved for large orders, and renegotiate with service providers.
2. Divest nonperforming assets. Decide if the company can sustain those projects and if it is worth it during a cash crunch.
3. Take out the right type of credit. Many companies can free up cash flow on 15% to 20% of their sales by managing working capital. Loans against equipment, receivables and the like typically result in low-interest, securitized loans.
4. Reduce available credit to critical accounts.
5. Draw on lines of credit immediately during a crisis. Yes, credit allotments do change!
6. Delay research and development. This shouldn’t be indefinite, but several months of delayed research can free up the critical cash flow needed to save critical existing customers. Often, research can be recovered in a way that critical client volume cannot.
7. This is unique to the Covid-19 crisis: Make sure to apply for both EIDL and PPP as soon as possible.
8. Change the sales channel. Does online marketing work for your product, and are your reps able to adapt to the new methodology of selling?
9. Consider a capital raise at a discounted valuation, especially as a growing startup. We ended up raising capital at a lower valuation than the industry average for our stage, but we picked up several key investors who were more likely to come on at a price point that they likely would have passed on in other times.
10. Look at raising from different asset classes: private equity, growth equity, sovereign wealth funds, PE firms, family offices and cash-rich investors. There are many sources of capital that are often overlooked.
11. Consider venture debt if you’re working with a reputable venture capitalist who has a relationship with creditors.
Careful analysis and thinking about cuts and actions in a framework that supports the overall company strategy will lead to better decision making. This is the time to not only find creative backstops, but also to set your business up for success when we emerge from the turbulence.
