How startups can shift gears and overcome the downturn

In times of economic expansion and prosperity, raising capital for a startup is much easier. Investors feel encouraged to pump capital into nascent sectors because the prospect of higher returns is more attractive.

However, the landscape changes when there’s a crisis. Now, founders need to contend with the dual catastrophes of the Covid-19 outbreak and the stock market crash. Though these hurdles may initially seem insurmountable – particularly for early-stage companies – it is possible to ride out the storm and use the circumstances to one’s advantage.

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First, entrepreneurs should focus on creating a financially sustainable business. In an article by the Harvard Business Review, studies found that during the recessions of 1980, 1990, and 2000, 17% of the 4,700 public companies that were analyzed fared particularly poorly. They either went bankrupt, went private, or were acquired.

The same study found that 9% of these organizations did not simply recover in the three years after the recession but flourished and outperformed their competitors by at least 10% in sales and profit growth.

What differentiated the success from the failures was the ability to recalibrate in difficult situations.

Typically, businesses juggle between pursuing a growth-oriented strategy or a profit-centric approach. However, cash-strapped situations necessitate greater emphasis on generating revenue and profitability. This can be achieved by implementing more cost-cutting measures, carefully monitoring expenditure, and sticking to a strict budget plan in order to minimize burn rate.

Though early-stage startups lack the luxury of developing business continuity plans or huge cash reserves to fall back on during tough times, simply shifting gears and prioritizing profit over growth makes a big difference. Firms that possess sound cash flow management have a higher likelihood of surviving – and even thriving – once periods of economic downturn passes.

Moreover, tumultuous market conditions can create points of access to resources. Higher unemployment rates, for instance, present a wider pool of talent to choose from. These unique conditions allow companies to expand their businesses and make the most of their growth once the downturn dissipates.

Entrepreneurs who are able to capitalize on these points of access and simultaneously streamline costs to maximize profitability will stand out as one of the rare few who can hold their ground amid economic instability.

Second, startups need to be prepared to face a harsher fundraising environment. Reports have indicated that financial crises are associated with a 20% decrease in the average amount of funds raised per funding round. Though this is more common with mature companies, the lack of capital in the market does suggest that those seeking funding will face similar issues.

Additionally, when investors flee stocks during market dips, public and private valuations will inevitably be slashed in conjunction with lower stock prices. If valuations tank, these firms are often forced into down rounds that diminish the value of common stocks.

Therefore, founders should adopt a more flexible mindset when planning to fundraise. Though entrepreneurs usually negotiate over valuation to lessen their relative dilution, this would be the opposite case when there isn’t as much capital in the market, as investors have the upper hand. Hence, in a down economy, entrepreneurs should expect lower valuations and, in turn, be prepared to accept more dilution in order to survive.

Startups that enter fundraising discussions with a more conservative outlook on valuations have a higher chance of being funded in spite of the negative market situation.