Managing Start-ups During an Economic Downturn

Economic cycles are a reality of life. Founders need to be aware of the fact that their start-up company could find itself in the middle of an economic downturn. Such situations tend to be the real test of start-up companies.

The poorly managed start-ups face severe cash flow issues during such recessions. A lot of these start-ups end up closing down during such recessions.

It is important for the founders to understand that the external economic climate can change at very short notice. Therefore, it is important for them to build a recession-proof start-up.

In this article, we will have a closer look at the various steps that start-ups can take in order to ensure that their start-ups are able to survive the downturn.

1. Structure a Scalable Business: It is often said that a successful business is built even before there is a business. The same can be said about a resilient business as well. There are certain types of companies that are better at surviving downturns as compared to other companies. These companies begin their operations with very low overheads. All their costs are related to the actual manufacture of products. Hence, in a downturn when production is reduced, the costs also go down.

   Start-up founders must find creative ways to ensure that overheads are kept very low. Nowadays, a lot of start-ups have started embracing the work-from-home culture. This allows them to avoid the costs of renting a large office space in an upscale building. Similarly, many other techniques are used to ensure that the business remains asset-light and does not have any debt payments.

   There are many start-up companies that do not deploy full-time employees. Instead, they use the services of freelancers till the time the company does not have stable revenue. This might seem like a wastage of money when the going is good. However, the company is not obligated to pay freelancers. They can terminate the services of freelancers whenever they want. This flexibility helps founders perform better during the downturn.

2. Cut the Cash Burn Rate: There are many start-up companies that focus on growth instead of profitability. They want to capture the market share before their competitor is able to do so. However, this strategy can cause failure during a downturn.

   During a recession, all the players in the market are generally short of cash. Hence, it is unlikely that any of these players will try to capture more market share. Hence, start-up companies should try to focus on improving per-unit profitability. This will allow them to reduce the rate of cash burn. If the company is burning cash at a slower pace, then it can use the same amount of money for a longer time duration. This helps the company survive longer without receiving any funding during the downturn.

3. Survive with Downrounds: It is important to realize that a stock market crash generally accompanies a recession. This often means that a lot of the funds are trying to sell their holdings in order to cover their positions in the market. This leads to an overall outflow of funds from the equity and debt market.

   The market for investment in start-ups is even more impacted because of downturns. Investors are not looking to make further investments. This can be detrimental to a start-up that may require more cash just to pay its bills. Start-ups cannot wait for a long time and hence they do not have sufficient bargaining power.

   Hence, start-up founders must be more flexible. They should be willing to accept a lower valuation and give more equity to investors if they want to survive. Being fixated on previous valuation numbers can jeopardize the survival of start-up corporations.

4. Use Alternative Funding: It is common for start-up funding to reduce during an economic downturn. Start-up companies must try to survive without going in for a funding round. There are some sources of alternate funding such as revenue-based financing which can be considered by start-up firms during such stages.

   It is important to note that the interest rates will generally be high during this period. Hence, it is possible that the start-up may have access to debt. However, it is of utmost importance to ensure that the debt is utilized sparingly. Many start-up companies have taken on a lot of debt during an economic downturn only to go bust at a later stage.

5. Cut Costs: Last but not the least, start-up companies may have to cut costs to stay afloat. However, companies need to be careful which costs they cut. If they reduce the perks of all employees, the company may not face such a big backlash.

   However, if the company tries to lay off a large number of people, it may attract a lot of negative publicity. The same company may find it difficult to attract quality human resources at a later stage. Hence, the company must try cutting all other costs first. Layoffs must only be done if there is no other alternative left.

A recession can be the litmus test for a start-up. Companies that were not built on a solid foundation will fail whereas those that were built on a solid foundation will survive and prosper. In fact, in many cases, an economic downturn can turn out to be a catalyst that can spur growth.