By: Mohan Kumarmangalam & Alok Jagdhari
Companies’ success in the next 18 months won’t be determined by their growth or profitability, but merely by their ability to survive and not run out of cash
A Corona hockey stick is currently sweeping through the world of Indian startups, leaving some without a job, others without decent pay, and everybody in a state of fear, insecurity, and uncertainty. The advent of the gravest financial crisis in the last 91 years has caught the investment community like a deer in headlights.
No one, bar none, was prepared for the magnitude and scale of the economic crisis facing the world today. As a result, not even the smartest, savviest investors had ever prepared for this kind of a global pandemic and economic depression rolled into one.
Fundraising in India was soft in 2019, peaking in the third quarter with $2.5 billion in funds raised and ending with a mere 2% year-on-year (Y-O-Y) increase in value terms, compared to a 102% increase in the prior year.
Furthermore, the year was marred by a steady slowdown in the number of deals, falling 19% from the first quarter to the last. The year was also marked by a shift in strategy for most venture capital firms, moving away from companies that needed to burn significant capital in order to achieve their milestones to investing in companies with a solid path to profitability.
The greatest challenge in approaching this year as a venture investor is the lack of a comprehensive understanding of the pandemic’s nature, its breadth, or the likely exit from the current state. No one alive today has witnessed anything of this magnitude and, for once, we are faced with an economic climate where the length of the COVID-19 crisis, its likely resolution, and the shape of the future is entirely uncertain even 3 months after the beginning of the crisis. Thus, it is not surprising that most investors around the world have closed their cheque books to startups looking for another shot in the arm, and startups now have no other option than to extend their runways with the cash they have on hand.
In fact, many investors in unlisted securities are now looking to deploy their rapidly depleting capital into existing ventures they already have an investment in, with the hope of sustaining them through the crisis.
While existing companies struggle to raise subsequent rounds of funding, new companies looking for seed investments will also have a tough time raising money in this environment. The lucky few startups that recently raised money or have substantial cash on hand have likely put their money in a deposit, waiting for the end of the lockdown wherein their resources will likely buy them a lot more than they had expected.
It is our belief that businesses will eventually resume normalcy. However, this normalcy won’t be a return to the normalcy of January 2020, but a “New Normal”. Hence, we are recommending all investors and entrepreneurs to prepare for this new normal. What will this new normal look like?
As venturers, we are committed to at least hazarding a guess. The glimpses of the new normal are visible in the current response to the COVID-19 pandemic, viz depleted incomes, depleted savings, and massive destruction of wealth.
It is also being manifested through social distancing measures and lockdowns. It is our belief that some of these behavioural changes will persist and become the new norm. Hence, people are very unlikely to hop onto a flight or catch a train with the same alacrity that had become normal in the last two decades.
Similarly, leisure and entertainment are unlikely to ever return to the trajectory of January 2020 in the foreseeable future.Given the immense destruction of wealth due to the crash in asset prices, investors are unlikely to return to the same asset classes or risk assets as they had been doing for the 10 years leading up to this crisis.
The extraordinary fiscal and monetary measures being undertaken by the governments in the developed nations have put a bottom under these economies. While it is unlikely to lead to growth in these economies in the near future, it will prevent the widespread misery and destitution caused by the Great Depression.
However, this also means that fiscal deficits totalling 10-15% of the GDP are now the new norm for the next two years. It is also an uncomfortable truth that these deficits will need to be paid back, resulting in higher taxes on the wealthy and on companies.
For companies, our advice is to build a cash runway for at least 18 months, i.e., till September 2021. We expect the discovery of vaccines, prophylactics, antivirals and quick testing to take another year to reach the global population, which is an important prerequisite to the restoration of any semblance of normalcy.
Hence, we are advising all start-ups to build a best/planned/worst-case scenario for their revenues and for their costs. This will give them a 3×3 grid, into which they can tabulate their cash runway months using the combinations generated and then choose a suitable combination of revenue and cost scenario to plan ahead.
Difficult decisions will need to be made. All assumptions about businesses must be abandoned and everything thought through from first principles. All entrepreneurs must anticipate where the revenue, rupee or dollar will move and then change their business plan and product mix to get a share of that revenue.
Costs will need to be cut ruthlessly while ensuring a humane treatment of their employees and dependents. The current crisis is especially difficult for managers, executives, and entrepreneurs who have been trained to maximise profits, revenues etc.
They now must plan for survival. Their success in the next 18 months won’t be determined by their growth or profitability, but merely by their ability to survive and not run out of cash. The old adage of ‘Cash is King’ has never rung truer.
(Mohan Kumaramangalam is an Angel Investor, Alok Jagdhari is Partner, 92Angels)