How to Prepare Your B2B Software Startup for a Bumpy Ride
"In a crisis, be aware of the danger, but recognize the opportunity" ― John F. Kennedy
Over the past week, there are a wide range of reactions from founders and investors alike, few optimistic with most anticipating that the worst is yet to come.
With a sharp decline in the public stock markets and Sequoia and Mark Suster (Upfront VC) communicating that we should prepare for a global recession, it is clear that distress is spreading from consumers to businesses. We must keep in mind that Software and SaaS spend has outpaced growth in India by 1% and 11%, respectively. Hence the market urgency and relative opportunity will not fundamentally change (see 2019 Battery presentation for details).
With uncertainty, comes opportunity. Now is a great time to design your startup for scaling and sustained growth by staying lean and clean. This means understanding sensitivities in the business and being prepared to act quickly & decisively.
Before addressing the question “Who should a startup raise from?” as a continuation of “The Science of Financing a Software Startup” published last week, I thought it would be useful to share some practical strategic and operational tips for software startups and their founders during times of uncertainty and a potential economic downturn.
In this article, I will discuss the following topics:
Spring is the best time to get your house in order and invest in the right resources.A practical framework and operational tips to prepare for the worst.
Dark Horses, Stallions, and Zebras that create real value will stand out in times of uncertainty. A brief revisit to the fundamentals of a great business.
Stay calm, carry on. Hustle smart, hustle hard. My personal experience during 2008 to 2012.
Spring is the best time to get your house in order and invest in the right resources.
Screenshot of Google search for “Practical Guide to preparing for a Global Recession”. #1 is debatable for software or SaaS scale ups.
The beauty of modern day B2B software businesses (often SaaS) is they have negative working capital and (at scale) high operating leverage* (a double-edged sword in a downturn). In other words, customers are providing the cash to fuel business growth and there is no cash being tied up in inventory, manufacturing, or in the supply chain. The customers you work with are loyal and ‘sticky’ (unlike fickle consumers who often overindulge during good times) and your company is solving an urgent and unmet market need. There will always be a budget for that — it will just take longer.
*High operating leverage is great for growing quickly, but the challenge is that the business is more sensitive to fluctuations in cash flow. If customers take longer to pay, company continues to attract talent, and/or there is too much debt outstanding, then it can become tricky to manage a business if it is not clear whether the bottlenecks lie with market, product, sales, or marketing.
How does a startup operationally prepare for the worst?
1. Cut back on unnecessary costs and maximize flexibility
Non-essential travel and accommodation
Big and expensive offices with long term lease commitments
Lavish snacks, food and drinks
Other startup perks that do not contribute to revenue
Employee happiness is important, but being employed at a profitably growing company matters more to overall well-being.
2. Make sure customer and employee interactions are measurable and predictable
Implement and use accurate & relevant data, tools and systems to make daily decisions. Invest in best-in-class CRM, ERP, and project management systems (e.g. Salesforce, Netsuite, Jira) as well as tools that support marketing, sales enablement, customer support, customer success, forecasting, professional services, business intelligence, talent, and communications. You need to have clear visibility across the business to be able to act nimble.
Now is a great time to try remote work for all employees, not just developers. Google, Microsoft, and Zoom are offering free work-from-home software. (Zoom stock (NASDAQ: ZM) is up 22% in the past month.) As previously mentioned, Toggl and Hotjar have bootstrapped to over $15MM and $25MM ARR, respectively, and both companies are fully remote. There seems to be a positive correlation between remote work and value creation.
3. Closely monitor cash collection
Cash payments should be relatively predictable, as two-thirds (or more) of startup cost is talent compensation. A business can track its cost structure relative to expectations before hiring by regularly updating its operational model with accurate (i) time to hire, onboard, ramp, (ii) performance and (iii) compensation data. In addition, ensure paid marketing is attributable by channel and there are clear KPIs and benchmarks for spend.
Cash collection from customers is trickier to forecast, especially in enterprise sales. The best way to manage this is to have:
Clear go-to market strategy and tangible execution plan
Send customer invoices on time
Make sure customers pay on time
Turn loyal customers from monthly or quarterly to annual or multi-year payments (and offer discounts)
Incentivize your sales force to close annual or multi-year contracts
Get marketing and sales to prioritize customer logos and customer case studies, as brand matters even more
4. Have 18 months of cash runway
Once #1–3 is completed, use your financial model to forecast what a great, good and bad scenario looks like. Make sure the company has at least 18 months of cash runway. If this means raising from your existing investors or going out to the broader market to attract new investors, do it as soon as feasible. The public markets over the past decade have shown a tendency to be volatile between the months of April to July, and this could impact the responsiveness of VCs when it comes to decision-making and valuations.
VCs have raised a lot of money over the past two years and it needs to be deployed into businesses at a pace promised to LPs (“Limited Partners” a.k.a investors in private funds). Investors are acutely aware that a recession is (over) due for a few years now, and there is nothing LPs dislike more than money sitting idle, especially during low growth, low interest rate environments. Therefore great and good companies will still be able to raise money, albeit it will be at more reasonable valuations (like those 5 years ago) in order preserve capital for existing and future portfolio companies. So overall, a downturn could actually benefit the sustainability of a vibrant venture ecosystem. For more information on ‘dry powder’ (i.e. capital to be deployed), read this article and this one too.
When I Googled “Practical Guide to preparing for a Global Recession” (see image above), the first tip that came up was “Pay down debt”. I agree with all the others, except this first one. The reason is that debt — when structured prudently — forces a business to be more disciplined in growth as it requires reasonable business visibility, though this comes at a price of near-term cash flow. Growth at all cost is only valued by VC (equity) investors. In the medium-long run, a mixture of equity and debt is the most healthy and cost effective way to finance a predictable, profitably growing venture-backed software business.
Dark Horses, Stallions, and Zebras that create real value will stand out in times of uncertainty.
Dark Horses will finally get the attention they deserve
Some of the best global software businesses were launched right before or during the recession — Spotify (NYSE: SPOT, valued at $25BN), Adyen (AMS: ADYEN, $22BN), Zendesk (NYSE: ZEN, $8BN), Unity (private $6BN), Elastic (NYSE: ESTC, $4BN), Medallia (NYSE: MDLA, $3BN)— to name a few European born. These companies were not clear Unicorns in their early days.
As mentioned last month, growth at all costs is not sustainable or desirable. In times like today, it is important to revisit the fundamentals of what makes a great business irrespective of its maturity. Experienced software investors who have worked with private and public companies across stages of growth have great insights.
Bill Gurley (Benchmark) wrote a great piece in 2011 which discusses why All Revenue is Not Created Equal and evaluates businesses on an adjustable weighted average 10-points scoring framework (below):
Further, it is also talent, not just money, that creates long term value. When faced with uncertainty, bright and talented people are more inclined to join businesses that present the most opportunity, which is not necessarily the ones that receive the most funding from VCs (since the capital supplied to startups has flipped as discussed here and here).
As Salesforce CEO expressed in a recent earnings call (summarized here, full transcript here), you may end up regretting it if you are overly conservative and cut back on investing in sales talent too much.
It is always best to be prepared for the worst, but you should continue to pursue the right opportunities that create real value.
Stay calm, carry on. Hustle smart, hustle hard.
New York City skyline
My personal experience during the Global Financial Crisis was challenging yet incredibly rewarding.
In summer 2008, I pursued an internship in investment banking. Two months later, Lehman filed for bankruptcy, Bear Stearns got bailed out by JPMorgan, and AIG went through a government restructuring. Goldman Sachs put me into a holding pool (only Wall Street Bank to do this), which meant no Canadian bank wanted to hire me.
I turned into a Business Development Representative (“BDR”) calling every Ivey alumni in Finance from Hong Kong, Dubai, London to New York. At the same time, I prepared for the worst by studying for my GMATs and applying to grad school in the UK.
Two months before I was planning to move to London to study at LSE, I got a call from an alumni mentor who worked at J.P. Morgan in New York. Calvin asked if I was interested in a role in his group, a thriving startup within Sales and Trading working with US pension plans. I hopped on a plane the next day and received a job offer shortly after. Three weeks later in May 2009, I officially moved to Manhattan. With no family or friends there, and little money, I lived in a YMCA for a brief period before finding a tiny apartment close to the office and receiving my first paycheck.
Nine months after joining, J.P. Morgan underwent a leadership change and announced its plans to divest the group and sell the business to an insurance company. I decided to stay with the bank and return to corporate finance, joining the Syndicated and Leveraged Finance team (which provides a full suite of debt products to corporates and enterprise businesses across industry sectors).
I worked with and learned from some of the most impressive leaders, such as Steve Hazy and Mike Milken, and also personally grew a lot during the worst years of our past recession. And came out the other end much more resilient.
In times of uncertainty and hardship, it is important to:
Invest time wisely
Communicate with radical candour
Be agile and responsive to change
Work smarter and harder
In the medium-long run, everything works out how they are meant to. For now, stay safe and focused. Be prepared for a bumpy ride, yet try to stay positive and appreciate the lessons of a rollercoaster journey.