The pandemic has limited access to once potent VC funding. Businesses must now look to alternative means to create a cash runway that will sustain them over the coming months.
Small businesses and startups have served as the catalyst for technological innovation over the last decade, both through their own product offering and by applying pressure to industry incumbents. A growing number of startup successes – from Facebook and Square to Uber and Zoom – were fueled by a venture capital (VC) funding model flush with cash. Seemingly limitless funding rounds, bolstered by foreign capital and accelerated by low-interest rates, allowed founders to focus on growth, often leaving unit economics or profitability as an afterthought. This model brought us titans that leveraged ever-growing valuations to buy market share.
Then the pandemic hit. The resulting economic contraction put a major strain on this model. No longer do small and mid-size businesses have high-growth forecasts to generate higher valuations and raise capital. This is compounded by contracting sources for VC capital. Despite many states reopening, it's safe to say that commerce will not simply snap back in a "v-shaped" recovery. With a pullback from investors and uncertainty around revenue generation, many startups must seek alternative means for maintaining cash flow and extending the runway for cash on hand.
This quick reversal of VC funding has proved particularly troublesome for many high-growth startups reliant on cash to fuel continued growth. Every year for the last six years, VC funds raised $35 billion or more. But investors tend to pull out of higher-risk illiquid asset classes in times of uncertainty; Q1 2020 is expected to show a dip in VC funding, with further declines setting in in Q2. For comparison, VC fundraising fell by almost 60% in the first years of the Great Recession. Fundraising efforts aren't immune to market cycles and VCs will face pressure from their own funding sources. With liquidity sources tightening, VCs are reevaluating how and when to deploy capital, making it harder for startups to close funding rounds and secure new investment interest.
In addition, demand and sales growth have slowed significantly in most industries. Both consumer and business spending habits have changed in the short run and larger shifts can be expected down the road as the pandemic accelerates the transformation of habits and spending patterns. Growth stage businesses may be feeling the most stress as their existence is tied so heavily to delivering on growth forecasts. No one knows when the dust will settle, and these companies need a runway until they get a better idea of what the other side looks like.
There are a number of options businesses can consider to extend their runway during such economic uncertainty and when VC funding tightens:
Driven by strong guidance from their backers, founders are on a cost-cutting mission. This is often an obvious approach, with line item reduction being a common exercise. Sometimes, this falls on employee headcount, although most businesses prefer to avoid this route. As of this writing, 450 US startups have laid off over 60,000 employees. Teams are looking to reduce infrastructure spend while founders are taking pay cuts.
As more businesses work from home en masse, office-related expenses may be the first on the chopping block. Many businesses, for example, are questioning the needs for expensive and expansive office space and all of its associated costs. For some, this is an easy way to cut expenses and free up cash. Businesses may also be looking to consolidate technology and reduce their tech stack or vendor relationships. Such cost-cutting is exacerbated by a shifting work model where the technology and vendors that once proved vital are now no longer essential. But expenses can only be cut so much without sacrificing any hope of growth.
Capture new revenue
When cost-cutting is simply not enough, revenue generation can be an advantageous approach. Creating new streams of cash flow can help a business stay afloat when other revenue streams dip or planned funding dries up. On the inflow side, some businesses are attempting a short term pivot, like Airbnb's virtual travel experiences, in hopes of capturing some revenue. Other businesses, like Everlywell, pivoted to capture new market share and redirect the future course of the business. This can be a particularly attractive solution to generating cash, especially given changing spending patterns and behaviors due to the pandemic.
For some businesses, economic downturns present opportunities for growth that weren't possible previously. This of course is not always a guarantee – but oftentimes of desperation seed great ideas. There are countless stories of businesses across the nation, faced with slowing or in some cases halted revenue, identifying new opportunities for growth and revenue generation. In some cases, these pivots were implemented in mere weeks, setting the business off on a path it would have never traveled otherwise.
The beauty of creating new revenue generation is that it can be a tool for offsetting cost-cutting initiatives, including layoffs. But sometimes a business pivot requires an influx of cash to finance new opportunities.
Explore lending options
Cash on hand is a steadfast tool for fueling growth – its why we've seen so many funding rounds for private companies that are looking to scale, and often scale quickly. For the last several years, VCs were the main source of capital for growing businesses. But without the option to raise money from VC sources, businesses are increasingly turning to traditional and alternative lending markets. A business likely first stop is the bank. Traditional banks – both national and community – are limited in their lending offerings, particularly to small and mid-sized businesses. The easy access to funds that a business generating $25 million or more may be able to access won't reflect the experience of a small business. Banks are also not lending to new clients unless they come with a 1to1 loan/deposit relationship. They're not willing to add assets to new clients, and instead sending these businesses to alternative financing sources. Limited operating histories and uncertain cash flows can make SMBs “undesirable” candidates for a bank’s lending programs; banks will unlikely find high-growth businesses a good lending partner.
The next option is alternative financing that leverage assets such as real estate or equipment. There are a number of alternative lending sources that have popped up over the last five years, focused on serving these SMBs specifically. These lenders provide alternative means of capital for businesses in the $5 million to $150 million range. One such means is asset-based lending, which takes into account a business's physical assets as a means to generate liquidity. This can be a solution for some, but not those that are asset-light in nature.
For these companies, programs such as invoice financing can be a reliable resource for funding. This is especially useful for enterprise-facing companies. These programs allow businesses to leverage their commercial accounts receivable to accelerate cash flow. Unlike debt or other cash flow style products, this is typically a flexible source of capital with no monthly repayments, covenant-light contracts, and a non-dilutive structure. Businesses typically gain access to invoice finance programs directly through a provider, or even through customers who offer financing programs to suppliers.
Whatever a business decides is the best route, preserving cash on hand during turbulent times is necessary. Creating a runway is essential for surviving the uncertain times ahead, and will ensure a business is able to recover once the economy shifts back into growth mode.