Lessons from 1955 Capital CEO Roundtable
Recently, the 1955 Capital team organized a virtual portfolio company roundtable with 11 CEO’s discussing the current challenges in the COVID-19 environment, the need for strong leadership in this unprecedented crisis, and response strategies that they have undertaken.
Here are some of the many thoughtful perspectives that were shared in the course of the discussion:
1. Investor sentiment in the current environment will be severely restrained, so it will be critical to rethink approaches to fundraising.
Fundraising will be challenging during this time, especially when targeting investors with large portfolios, who will be spending much more time focusing on existing companies instead of pursuing new deals. For firms with large partnerships, GPs may be fighting to get continued support for his/her companies and be distracted by an increased number of distressed situations.
New opportunities may be harder to get voted through partnerships, especially given increased constraints on completing due diligence. Investors may not be able to visit your site, meet your team, and engage with your products. You will need introductions that are well qualified and vetted, leverage your current investors’ and colleagues’ relationships and political capital to flag senior-level attention, so that it leads to a real conversation. A good place to start may be the list of investors you’ve spoken with. As many may be more constrained in their ability to do new deals, they may be more open to revisit past conversations and leverage prior diligence.
Looking at past downturns, many funds will go into hibernation mode. Many firms raising funds in 1999–2000 slowed their pace dramatically in the 2000–04 timeframe and did fewer deals despite, in some cases, raising large funds. The GFC in 2008 also saw several years of hibernation for many firms before a rebound. With COVID-19, there is an additional layer of uncertainty around the manner by which the market will come back, with wide variance in when deal making may return to a more “normal” pace; for example, the latest research from Harvard suggests that some form of social distancing could last well into 2022.
Entrepreneurs will need to get more creative and prioritize pockets of capital that remain active and interested during this period:
- A number of funds recently raised capital, want to deploy, but can’t source and diligence as before. They may rely on funds and GPs they know and trust to take a closer look at pre-vetted deals. Your board and investors can help you identify and qualify these sources.
- Family offices are less bound to institutional frameworks for capital deployment, and may not have broad exposure to early- to mid-stage venture opportunities. For groups that are well capitalized, with core businesses less affected by COVID-19, they could see this as a buying opportunity or good time to enter longer-duration assets.
- While corporate VC firms (CVCs) may be difficult to access in the near-term as their parent companies deal with the COVID-19 impact on their core business, including layoffs, distress on their balance sheets, and downward pressure on stock price, etc., the tide for some may turn when the market reopens. Their parent companies will eventually need to refocus on driving revenues and growth and may be more willing to partner with technology companies that can increase their chances at doing so — especially if prior customers and profit streams are no longer there after COVID-19.
- There are also other potential sources of non-dilutive funding, including government grants and R&D programs, particularly for technologies that are beneficial in areas that can help countries address key infrastructure or supply issues and recover more quickly from COVID-19.
- When investors are adhering to social distancing and limited on ability to travel, it levels the playing field for startups pursuing investors from other parts of the country or globe. Investors from the other coast, in Asia or in the Middle East are a few clicks away on Zoom. Find ways to turn this into an advantage assuming you have properly qualified true investor interest in your company.
2. Runway planning is essential during this environment and can mean whether startups will survive or fail.
Runway extension becomes critical for all businesses with the uncertainty of COVID-19’s impact horizon and lack of consensus of longer-term impact.
- Timing and duration will be difficult to predict, and the “experts” have never dealt with a crisis like this. On 2/26, President Trump proclaimed that the U.S. only had 15 cases; the U.S. is expected to cross 2,500,000 by mid-July. Was anyone predicting that we would have 22 million Americans filing for unemployment in the 4 weeks after the start of shutdowns? The inherent unpredictability of “black swans” like these underscore the importance of having sufficient dry powder to weather through a variety of outcomes.
- Engagement with strategic partners who have suffered severe declines in their businesses and significant downward pressure on their market caps may slow to a crawl. They may not be active for several quarters, reassessing their own businesses and dealing with furloughs and budget cuts. Startups depending on strategic partners “returning phone calls” may need to decouple their burn rate from the unpredictable timing of a return to normal partnership activity.
- Runway extension is more than just holding monthly burn rate constant — presumably following a reduction relative to budget) to make cash last until the market turns. You have to plan for (1) time to raise your next round and (2) ability to meet milestones in advance of raising the next round. In the illustrative exercise below planning monthly cash burn over time (original budgeted case depicted by blue line), cash out is assumed to be December 2021, which may require fundraising to begin June 2021 at the latest. The company had planned for an increase in spend to begin April 2020 and just over a year of time for go-to-market activities and production developments to support milestones.
To both extend runway (here, depicted in red and green lines) and keep the company on a trajectory to increase value for a future round, the company needs to think creatively to achieve some combination of:
Maintain same area under the curve:
1.) reduce non-essential expenses and prioritize spend on value-creation activities important to future funding round
2.) Reallocating fixed capital to monthly burn, e.g., reducing your original capital expenditure plan or other fixed costs
3.) reducing go-to-market spend — i.e., a change in the pitch of the spend ramp — without sacrificing too much on value-creation milestones
Increasing area under the curve:
4.) raising additional debt capital or other non-dilutive funding
- From a CFO partner who works with 7–8 startup companies: We are working with 7–8 clients and March to June 2021 is the bare minimum to where you want to extend the runway. Many clients don’t think business will ever return to normal. For example, in real estate, folks are breaking leases because they don’t believe employees will go back to the office even after things lift.
- From another advisor who is working with multiple startup companies: Companies should aim for 12–18 months to get through mid-2021. A very well-respected VC that has worked with Andrew and me advises companies to aim for even longer, 18–20 months, potentially into 2022.
Budget planning and revisions will require some tough decisions by most companies.
- It will be important to consider short- vs. long-term impacts. You cannot simply take the axe on your budget to target a particular cost-cutting threshold. At the same time, it will be difficult to invest heavily to build the business in the way you originally had in mind. Balancing what expenses to cut while (1) still targeting milestones that build a strong investment case for future investors & partners and (2) investing for the future will be delicate but essential. Many companies need to build strategies to maintain basic operations while sustaining relationships and progress with strategic partners, advancing R&D and product development efforts, and continuing commercialization and scale-up activities.
- Even companies that have recently raised significant capital have taken a hard look at their expenses and reduced their budget down to the most essential activities that achieve the right milestones and deliver shareholder value. One analogy used here by one of the CEO’s: it’s like we are flying an aircraft under very low visibility conditions, and need to use IFR (instrument flight rules) — operating without visual references and relying on your instruments only. You need very precise instruments (i.e., a highly-accurate budget with many contingency levers) and need to react real-time.
- A well-reasoned budget will create room for optionality. Many CEO’s have extended their runway to get to a reevaluation point later in the year, at which time they may present an updated budget proposal to their investors and board based on an updated picture of the COVID-19 impact. It will be risky to maintain monthly spend levels or capital purchase plans if such plans are predicated on too many external factors outside of the company’s control:
- Are there signs of life with customer demand returning for your product/service?
- Are partners answering calls and able to commence with collaboration or joint distribution deals?
- Are regulators back in the office and able to give visibility on timelines for required approvals?
- Have restrictions on social distancing for production eased? Is it safe to bring workers back to the workplace or factory?
- Is travel reopening to be able to meet customers and partners to consummate deals?
Levers of cash management are many, but CEO’s will have to think creatively while making tough decisions.
- Payroll/salaries tend to be the largest cost category for many startups and an obvious place to start. CEO’s have considered a range of different approaches, including shifting to a more variable cost/labor model, deferral of salary, compensating with equity in lieu of cash, providing bonuses on the back-end, etc. Teams have also reduced costs through renegotiation of other obligations (leases), deferring payments, shifting to in-kind payments, etc. Cash on-hand is king.
- One CEO who has lived through multiple downturns structured his workforce with 30–40% as contract employees to provide maximal flexibility, and it has helped him weather this period more smoothly.
- Consider revisiting terms of strategic collaborations, as partners may be more willing to compromise during this time. Find ways to get more upfront cash payments, cost-sharing, and other in-kind support. Some collaborators (including government pilots) may be willing to modify the scope of projects to better align with your company’s core R&D spend.
3. Business development could be much more difficult during the COVID-19 crisis, with partners and customers dealing with a new set of problems and limitations on on-site meetings, so finding ways to “level the playing field” will be crucial.
Be nimbler than the competition. Downturns can present business development opportunities to startups that otherwise don’t exist in peacetime. More established companies may be less nimble and are tied down to existing business models and distribution modes. Startups have an opportunity to catch up or overtake giants in a way they don’t have in peacetime.
Build trust.It is more important than ever to continue building trust with strategic partners. Given decisions may need to be made on partnerships with limited to no face-to-face meetings, everything that contributes to building trust by proxy — your ability to deliver, what other partners and investors say about you or your product — becomes even more relevant and critical.
Break geographical barriers. Is there an opportunity to look at the global picture sooner? China and other parts of Asia have reopened their economies and will be doing everything they can to reverse the slowdown in the coming quarters. Being early to reorient business development activities to that part of the world could provide another important avenue to market.
Double down on key innovation and differentiation. Large companies have to slow down at this time and manage through a much larger scale of transformation to their businesses, giving startups a window of time to accelerate and out-innovate.
Proactively align interest with key stakeholders. With strategic partners all working from home, it may be easier to reach top-level decision makers who otherwise are too busy to meet with you. The reduction in travel logistics and internal meeting coordination may afford more time in the day for busy executives. For these executives who survive the initial culling at large companies, their career may depend on driving growth, and they may be more willing to take chances and partner with new technology companies that can help achieve that. More executives will be thinking about how to be relevant and ready in a post-COVID world, so finding ways to communicate your ability to help partners achieve that will be important. It’s crucial to be persistent so that when partners come back online, you are in a good position to continue making progress.
Rethink your distribution strategy. Given social distancing and sectors like physical retail, travel, hospitality, and restaurants slowing down dramatically, exploring distribution channels — in and out of the U.S. — that are more robust than in peacetime is important. Are there online, direct-to-consumer opportunities? Are there segments that you can attract online that would typically be difficult to target during peacetime? Are there global partners that you can work with sooner than you expected?
At the same time, many industries that are getting hit hard will need to aggressively spend marketing dollars and innovate on their products to get customers back, so you may need to parallel process. Startups that time this dynamic well may be able to manage through this crisis better than large companies whose channel strategy is already fixed. The ability to adapt is key.
Rethink target markets. Many startups have products with multiple market applications. Pre-launch companies have the ability to reprioritize their development efforts to target sectors that will be less affected by COVID-19. One of the CEO’s discussed the method by which is team reviewed their product matrix to shift focus on sectors like aviation and automotive in favor of customers in the luxury sector who were much more eager to deal in the near term.
Rethink operational strategy. Startups have had to get creative on how to manage their operations. One company brought up the example of their fulfillment center being in danger of getting shut down. In order to stay open, they ended up partnering with a food service fulfillment facility — a completely unrelated business — to leverage the unused factory space that was still in operation being an essential service. It was important in this uncertain environment to line up alternatives.
4. Team morale and culture becomes difficult to manage in a remote work environment, but more critical given the personal impact COVID-19 disruption can have on all employees and senior leadership.
There was general consensus that managing through a crisis together can be an opportunity to strengthen team dynamics. Several CEO’s have found that their team has bonded much closer together since the onset of the crisis.
Some CEO’s found it doubly important to take a more proactive approach with their teams, including having regular check-ins individually, creating virtual opportunities to replicate interactions that would have taken place in an in-person environment (like “walking the factory floor”), and finding creative ways for social gatherings online.
Some CEO’s have found it a useful exercise to get everyone to review their priorities frequently and on an individual basis. It helps anticipate frustrations and misunderstandings, which can be hard to catch and mitigate over Zoom. It helps align priorities and create clarity, which are essential during this time.
It is important to think of “team” in a broader sense, including partners and suppliers, and check-in on them. During a crisis, people remember those who took the time to nurture the network and relationship and share optimistic and positive news to build collective resilience.
5. A global perspective is even more critical during this time of uncertainty, and CEO’s cannot be too U.S.-centric and forget the rest of the world, which may be recovering faster or reopening markets on an accelerated pace.
It is clear that the recovery in Asia has begun, and governments are aggressively focusing on repairing their economies and restoring growth. Assuming distribution channels can be harnessed, these markets can be a key source of revenue growth. One participant has seen steady growth in Asia during this period, with 30% of their business now coming from this region — much faster than they previously expected. Companies like Impossible Foods and Beyond Meat are dramatically accelerating their efforts in this region given the growth potential, ability to access wider channels, and local demand that has increased.
Find on-the-ground resources or contacts that can inform you how customers and partners are acting in other geographies. Asia, due to its prior experience with SARS and other pandemics, appears to have been much stricter on COVID-19 procedures and have had a much lower viral penetration (notwithstanding lack of clarity on reporting from places like China). Based on the input of several of the participants, here are some of the current perspectives:
- Taiwan recovered quickly and is most operational out of the Asian countries; one of the participants has accelerated their launch here.
- Hong Kong is returning to normal operations, with retail stores, restaurants, and most businesses opening with clear social distancing policies in place.
- China (BJ/SH) is operational, but people are still avoiding retail stores / restaurants / large gatherings.
- Japan, Korea, and Singapore are in the middle, seeing increasing shifts to online consumption, but there continue to be challenges with a potential second wave.