The View from the Foxhole

March 31, 2020 | BlogBlog

Well, if there was any lingering doubt, the current pandemic is taking a serious toll on the health – of the populace and the economy – of pretty much the entire world. There is great uncertainty on both fronts going forward, and uncertainty at these levels, in and of itself, will only add to the economic turmoil.

In an earlier post, I suggested that high impact entrepreneurs and their investors will pay a price for all the turmoil and uncertainty, even if not, likely as high a price as some of their small business peers and historically revenue-sensitive industries in the eyewall of the storm—as for example airlines. Today, some of my thoughts, as someone who has been through several economic shocks that rocked the high-impact entrepreneurship and investing industry, on what the future might look like.

The Big Picture

While the news is generally gloomy, every cloud – so they say – has a silver lining. I see two here.

First, the venture industry is currently holding record amounts of dry powder.  Even if some of that melts away (there is certainly precedent for defaulting LPs and fund re-sizing), venture investors are well-stocked with the ammunition on which their portfolio companies are most dependent: cash.

Second, unlike the financial crisis of 2008, the broader financial sector entered this crisis in good shape. The banking industry has close to $2 billion of “Tier 1” capital reserves; the Federal Reserve has already reinstituted some of the key programs developed and proven in the 2008 recovery; and we don’t have the kind of monumental bad debt overhang like we had with the sub-prime mortgage debacle. The “patient” has taken a serious punch, but is otherwise in good health.

That’s the good news. The bad news is that while the prescription for the current crisis is straightforward (massive infusions of liquidity to counter the demand shock of shutting much of the economy down for any material period of time) the price is steep, and the details are complex and subject to much debate. Which itself creates more uncertainty.

There are some generalities we can say, though, at least in the context of the high-impact entrepreneurship and investing business.

First, while the sector was not, heading into the current crisis, as poised for a fall as the real estate business was in 2008, valuations across the sector were at all-time highs and already showing signs of peaking. There was already talk of “what comes next” in the air, mostly around pulling back from growth-at-any-cost investing model to a “cash-flow matters” mode. That shift will almost assuredly accelerate.

Second, there will likely be a significant pullback by “tourist” venture investors (corporate VC; mutual funds; traditional PE funds) that have been (even more so than in past bull markets) unusually active in the late stages of the recently peaking VC cycle. That will add fuel to the fire in terms of pressures on valuation.

Finally, while new financings have so far continued more or less apace, expect a slowdown in the coming months. As the inventory of deals in-process before the pandemic took hold get closed, expect to see de novo investments – new investors in new deals – slow down considerably until the outlines of the recovery start taking shape. Most investors are understandably focused more on the continuing viability of their current wagers than making new bets.

The Entrepreneur Perspective

For entrepreneurs, there are basically two priorities right now. Survival is the first, and by far the number one priority. Next is everything else.

The Imperatives of Survival. As an entrepreneur, the first thing on your to-do list is figuring out your shelf-life and what your options are for extending it. Think hard about cutting the burn rate while minimizing long-term impact on your upside. As generals trade space for time in strategic retreats, startup CEOs trade timeliness for cash in slow-walking exercises. In both cases, the “milestone” is preserving capabilities rather than achieving victories.

Having sized up your cash situation, and developed alternatives for extending the runway, get with your investors and find where you are on their own priority lists. Your venture investors should be busy triaging their portfolios and coming up with their own ideas about allocating whatever dry powder they have available. They’ll be developing their own thinking regarding which portfolio companies are the best bets for supporting through the crisis, and which are better left to bleed out sooner rather than later. Take your best shot at helping them put you in the former category.

The dance of the macabre between entrepreneurs and their investors in these situations is not one where either party should let the other lead. The companies – and the investors – that fare best will be those who are most creative in both suggesting and reacting to new ideas for extending the Ball. There’s only so much cash in the company/investor system: your job is to make sure – if it comes to it – that your company gets the last penny.

If all of that sounds a little dramatic, you didn’t live through the bursting of the dotcom bubble. I remember a common video game that made the rounds then, the object of which was to shoot the most pink-slips at the most employees in the shortest amount of time. It was played by investors and entrepreneurs alike. Gallows humor, for sure, but like most of that genre grounded in hard realities of the time. It was – and is – some consolation that most of those folks, at least the ones who knew the nature of the game they were playing, eventually got back on the horse. I know I did.

And on that score, keep your team informed. Be upbeat, but realistic. Think Churchill at the start of the Big One, not Westmoreland on the cusp of Vietnam. Inspire with the nobility of the cause, not the chimeras of victory. It’s a lot easier to leave someone behind when they expect it than when it comes as a shock. And before you get there, you’ll likely get better performance from the informed than the naïve. And if reality scares a few people off, you are probably better off without them.

Next, sit back, and remind yourself that you wanted this job. So, get on with it.

Everything Else. While you should always have one eye on the cash-flow hour glass (and at least half your energy dedicated to slowing the flow rate and adding to the reservoir at the top) times of crisis pose other challenges – and opportunities – for startups.

Continuing communication with all of your important constituencies should be a priority. Beyond investors and team members, keep in close touch with your partners – business, technical and even the industry generally. Be transparent, but frame your message around your confidence in the future and (sincere) interest in the trials and tribulations of your partners. Avoid sounding either oblivious to the real challenges or resigned to their predations. This is your chance to do something that could be very important in the future: demonstrate grace under pressure.

As you grapple with the immediate crisis, take any spare time to re-think the fundamentals of your venture, generally and in terms of how the world might look as the crisis passes. Given the likely impact of the crisis on the venture industry as discussed above, consider whether your plans – business, financial (including pre-exit and exit), and technical strategies and milestones might need amending in light of the expected new realities.

Take careful mental notes of how your various constituents inside and outside your company themselves deal with the crisis. Take special note of those who thrive under pressure, and those who wilt. You’ll learn a lot about who you can depend on in the future not just by who you can depend on now, but also by observing who others can depend on.

Finally, think outside the box. For example, unlike previous economic crisis, the government response in this one seems to (the jury is out as the implementing legal regulations are getting fleshed out) include real and material assistance for high-risk emerging businesses – even pre-revenue. Have a conversation with your lawyer or accountant about that.

Concluding Thoughts

As Thomas Paine said going into an even greater crisis, these are the times that try men’s souls. Times where good entrepreneurs prove their mettle by tackling the toughest problems and, win or lose, demonstrate real strength of character. They do that by sizing up the hard realities of the hand they’ve been dealt, and dealing with them decisively, with grace and determination. That starts, for most, with understanding and hopefully flattening the cash curve, knowing fully that it’s a process that will likely leave some good people (and some good companies) out in the cold. Hopefully, other people and other companies.

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