Sunday June 7, 2020

Covid-19: How tech start-ups can survive an Arctic winter

The financial ecosystem is being turned on its head, but there are ways to counterbalance your exposure to a coronavirus recession

9th April, 2020
Covid-19 marks the beginning of what resembles an Arctic period in the technology start-up ecosystem. Picture: LightRocket via Getty Images

For pretty much the last decade, the technology start-up ecosystem has been awash with capital. This is partly as a result of an explosion of companies developing groundbreaking technologies that promise major growth for investors.

On the supply side, there has been a huge weight of capital chasing yield at any price in a close to zero interest rate environment. Consequently, both funding round sizes and valuations have been on a decade long upwards trajectory as ambitious founders rightly loaded up with capital to boost the growth of their early-stage companies.

Today, we step into a very different kind of environment. As we enter a U-shaped downturn caused by Covid-19, where no one can predict the scale or length of the recession nor the extent of the recovery, there is every chance that global capital flows to the thousands of existing early stage loss-making tech companies will tighten and become scarce.

This represents a massive shift in the entire ecosystem that we operate in, affecting capital supply chains across the board with significant consequence.

To truly understand this difference, a zoologist's perspective of life is appropriate. Under this lens, the past decade has been analogous to the ecosystem in the Amazonian rainforest; a plethora of species and animals born into an environment rich with food – for which read “capital”. Survival in this type of ecosystem is about capturing as much food as possible as quickly as possible to outgrow competitors.

In this scenario, the dictum is: “The winners survive.”

Covid-19 marks the beginning of what resembles an Arctic period. Here, conditions are harsh and food is scarce. Metabolisms – for which read “growth” – are slow and the threat is starvation. In this scenario, the dictum is: “The survivors win.”

So, what can a company do if it is faced with an ecosystem that is changing from being capital-rich to being capital-poor? What measures can a company take to ensure its survival? One possible approach is one that Frontline Ventures, my company, employed in the Nasdaq bust of the early Noughties.

Assume your company is facing collapsing revenues but has six months’ cash runway without revenues.

In most early stage technology companies, the operating expenditure (opex) is typically 70 per cent people-related and 30 per cent other. If the whole team moves to a three-day week, then 30 per cent of opex can be saved immediately. Of the two days salary given up, employees are given back pay for one day payable in X months when the company recovers and are issued stock options for the value of the second day pay forsaken. In the non-people related costs of 30 per cent, savings equivalent to 5-10 per cent opex can usually be made.

So, by making these reductions a company that has six months’ cash left assuming no revenue can extend its lifetime to as much as 10 months. There will be some revenue in the six months, so this runway is extended further.

We would advise you as founders to be completely open with the staff in your organisations as they can see the rapid drop in revenues. Obviously, if revenue rebounds earlier then this scheme can be revised to adopt to circumstances. In our experience, such a scheme as outlined above can strengthen employee buy-in to the company in the face of these extraordinary times as all employees become lenders and stockholders in the company.

A variant of the above might be useful to consider for your companies as you face a coronavirus-induced recession.

Shay Garvey is a founding partner of Frontline Ventures

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