Start-ups should be encouraged that several of today’s unicorn were founded during or immediately after the 2008 financial crisis. Image: REUTERS/Bobby Yip
- COVID-induced difficulties attached to fundraising are having various implications on the start-up scene.
- There may be hidden local-government funding to be had.
- Start-ups need to raise new funds earlier than usual in their planning, as investors are more cautious in a downturn.
Quarantine and lockdown have had an economic impact on small businesses and large corporations alike. However, when it comes to the global start-up scene, the carpet has really been pulled from under these companies’ feet.
Given that they rely mainly on equity investments or convertible notes, they have been affected by the fact that in a downturn, these can turn into debt. The earlier stage the company, the bigger the risk.
Mainland China, which was hit first by coronavirus in December 2019 has, to date, 204 unicorns (start-ups valued above 1 billion USD) and the impact of COVID-19 has been felt heavily by them. Based on the Startup Genome report, venture capital deals in Mainland China decreased by more than 50% in the first two months of 2020, with CNN reporting a venture-capital-investment decrease of 65% year-over-year for Q1 2019 to Q1 2020.
This led to a loss of 28 billion USD funding for Mainland Chinese start-ups alone with its year-over-year 2019 funding decreased already by 50%. It was thought that the rest of the world could well follow suit in the months ahead.
Start-ups and investors alike must adjust to a new situation in which due diligence is switching from offline to online and may take longer than expected given the new market sentiment.
Here are four pieces of advice for start-ups looking to improve their current or near-future fundraising:
1. Tap into government support
Governments around the globe have been setting up special COVID-19 schemes and grants to bolster the current situation for all scales of companies.
Do your research and check local government agencies for start-up funding or emergency grants. This can range from short-time work arrangements with governments paying a certain percentage of employees’ salaries, to rent exemptions, tax payment delays and extra business-relief grants.
Examples of these include low- or non-interest bridging loans with government guarantees that entrepreneurs can tap into to keep their business afloat.
2. Extend your runway
Since the 2008 financial crisis, start-up valuations and funding rounds have broadened and soared. This has led to an increase in the burn rate of well-funded start-ups, a company’s burn rate being the monthly negative cash flow which is itself based on net spending and net income.
Having a great market outlook and technology is not enough to attract investors in an economic downturn”
As early-stage start-ups have no revenue, the burn rate is mostly equal to their total monthly spending.
Generally speaking, entrepreneurs should try to have a runway of at least six months to allow time to raise new capital. However, in a downturn scenario like the current one, six months isn’t enough to raise funds, and so it is crucial to extend the runway and start raising new funds earlier than planned; investors are more cautious and tend to focus on their existing portfolio prior to considering new investments.
The easiest way to keep the start-up afloat is by bootstrapping, relying on your own savings and revenue, cutting costs (this may include a hiring freeze), selling company assets or streamlining expenses.
Different approaches can vary greatly based on the type and size of the start-up. Both small and larger cost cutting can be combined, helping start-ups increase their runway to go through the current fundraising dry spell.
3. Lower your valuation
In economic boom periods, company valuations on the stock market skyrocket as do start-up valuations, with the number of unicorns reported by CrunchBase in the past five years totaling 613.
Traditionally, venture capital invests in the future, seeking a lucrative exit deal either through an M&A or IPO. If valuations are too high, the return on investment for invested capital decreases. Having a great market outlook and technology is not enough to attract investors in an economic downturn. Therefore, any valuation and potential exit scenario must be aligned with the current economic situation and investors’ expectations.
SCMP reported that the exit dealmaking outlook for COVID-19 is more dampened. Reducing the valuation sought and giving investors a discount compared to other investment opportunities, for instance, would be the right way to go.
That said, be cautious not to under valuate your start-up; this can be an undesirable sign that you desperately need investor capital.
Anticipating that the COVID-19 crisis and ensuing economic downturn could last several years, it is crucial to calculate capital needed conservatively”
4. Ask for less
Start-up founders wanting to attract investors can play with the asking size of the funding round. Huge investments are often publicised by the media, and yet the majority of start-ups will never raise funds at all.
Using the 2008 crisis as its reference, CBINSIGHTS reported that of companies that had secured their seed round beforehand, only 48% were able to raise their second round of funding, with 38% failing and 14% having already exited. In total, only 1% of the companies reached unicorn status and 67% were dead or self-sustained.
Such numbers illustrate how difficult it is to raise start-up capital. From an approach perspective, it is crucial to calculate how much capital is needed to keep the company afloat in order to reach key milestones, and cutting corners on unnecessary costs given that the goal of every company should be its profitability.
Anticipating that the COVID-19 crisis and ensuing economic downturn could last several years, it is crucial to calculate capital needed conservatively so that the next round of financing can be timed for a period of economic recovery.
Entrepreneurs should be looking for grants, streamlining expenses, lowering valuations and asking for less. Tech-savvy individuals must embrace the current climate of digitalization, remembering that several of today’s unicorns were founded during or right after the last financial crisis.
Which new companies will be born out of the 2020 crisis? We don’t know yet, but it’s no secret that in the coming years start-ups and unicorns will disrupt our societies, and change how we live, consume, communicate and enjoy in ways we can barely imagine.
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The views expressed in this article are those of the author alone and not the World Economic Forum.