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COVID-19 has been called the black swan of 2020. In an effort to curb the devastating impact of the disease, certain local governments have enacted emergency measures to promote social distancing, including shutting down non-essential businesses. Unfortunately, the impact of these measures has been a slowdown in economic activity.
Like most businesses, the growth and success of start-ups and emerging companies have been, and will continue to be, significantly impacted by this pandemic. Yet, there are proactive steps that start-ups and emerging growth companies can take to mitigate the risks to its operations and, ultimately, its survival.
1. Raising Capital
As in any economic downturn, raising capital to fund the start-up will likely be significantly more difficult due to a reduction in the availability of both equity and debt financing. Start-up funding and deal activity have already been negatively impacted by the outbreak of COVID-19. Start-ups should expect that private equity and venture capital investment activity will continue to soften and securing funding may take longer than expected. A lack of access to capital can derail a start-up.
Now more than ever, start-ups should work with trusted advisors to review their options for raising capital to ensure that their operating expenses can be supported by the capital available to them. Some of the issues to consider when evaluating potential funding are:
Impact on the Start-up’s Valuation: The economic uncertainty caused by COVID-19 has meant that calculating the valuation of a start-up or emerging growth company may be considerably more complex. Many valuations calculated before the pandemic may no longer be meaningful if COVID-19 has resulted in a material adverse change on the start-up’s operations or the industry in which the start-up operates. As such, start-ups should assess whether a reduction in their valuations will result in the terms of any future equity financings being overly dilutive to the current shareholders.
Debt Financing: Although interest rates are low, banks and alternative lenders may be reluctant to lend capital due to the economic uncertainty. As securing debt financings may become more difficult from traditional lenders, such as banks, start-ups may wish to look to non-traditional lenders and providers of venture debt. Start-ups should be aware of the cost of capital associated with these sources of funding to ensure that their cash flow can support the required payments.
Government Programs: Start-ups can search and determine if they qualify for any federal or provincial programs or loans which can be used to support the business. This includes measures introduced by governments to specifically address the financial uncertainty surrounding COVID-19.
2. Reduce Burn Rate
It is critical for start-ups to review their spending and gauge if they can scale back during these times of uncertainty. As a preliminary step, this may mean assessing the number of employees and/or consultants or eliminating or deferring capital expenditures until they are truly required.
Due to a limitation in available capital, start-ups should attempt to be as lean as possible while scaling and attempt to control their burn rate. Start-ups may wish to review existing agreements with suppliers to establish if there are any opportunities to reduce or defer spending. Organizations should review their cash runway and gauge if they can withstand the poor economic quarters that may be ahead. This exercise should assist in guiding contingency planning.
Start-ups should seek guidance from legal advisors to ensure that any action taken with respect to employees, contractors or existing commercial agreements does not put them offside with any agreements or laws that relate to these matters.
3. Communicate with Key Stakeholders
Subject to confidentiality requirements, continuous communication with key stakeholders is critical during these uncertain times. Clear and concise communication can reduce the risk of miscommunication and provide clarity as to the start-up’s operations.
Investors: Start-ups should provide investors with an understanding of how the organization is addressing the current economic challenge. They should also consider explaining how the investor’s funds are being used to adapt to the new landscape, including finding and servicing customers.
Advisors: Start-ups should lean on their advisors, such as legal and accounting professionals, to help avoid and navigate any pitfalls that may arise. Start-ups should also seek advice from individuals who have had experience navigating economic downturns.
Team Members: It is essential that start-ups communicate with team members during this time. Ensuring that team members are kept in the loop as much as possible will assist in increasing productivity and cohesiveness. It will also support the development of creative solutions to address the current challenges.
Key Customers: Reaching out to key customers to understand how their operations have been impacted is essential. They are likely also experiencing economic challenges and connecting with them may offer opportunities to foster the relationship with these clients and develop additional avenues to collaborate.
Suppliers: Start-ups can communicate with suppliers to determine if they will be able to fulfill both existing and future orders. Start-ups may wish to conduct a review of alternative suppliers for critical products or services to mitigate the risk associated with existing suppliers on the start-up’s operations.
Although challenging times are ahead for start-ups and emerging growth companies, resilient and nimble organizations can tread above water and even thrive. Organizations will need to adapt to face the current challenge and develop effective strategies to address the economic reality. However, this challenge should be accepted as an opportunity to demonstrate that start-ups are able to navigate tough times and are battle-tested.
Miller Thomson is closely monitoring the situation around the COVID-19 pandemic to ensure that we provide our clients with the appropriate support in this rapidly changing environment. For additional information, please see our COVID-19 resources page.