Monday, April 13, 2020
An Entrepreneur’s Guide to Surviving CoronavirusBy: Dror Futter, Legal and Business Adviser to Startups, Venture Capital Firms and Technology Companies Remember all those articles about whether venture was overvalued? With blinding speed, they now seem quaint. Bluntly stated, most venture-backed companies are in a fight for survival. Although certain areas of life sciences may do somewhat better, I think the impact will be widely felt. Complicating the fight is the fact that no one can predict how long it will last and what the immediate post-Corona economy will look like. To survive, entrepreneurs need to focus on actions within their control. Based on past downturns, it is impossible to overstate the importance of having cash in the bank and a flexible cost structure to weather the storm. This article highlights what ventures can do to increase their ability to survive the Corona Crash. First, the article discusses how the current situation is likely to impact your venture and your key stakeholders – investors, customers and suppliers. Then it highlights the levers you can deploy to lengthen your runway and increase your flexibility. How Will The Corona Crash Will Impact Your Venture
Why Does Fundraising Become More Difficult In a downturn, investors typically exhibit several behaviors that reduce available funding.
There are a lot of stories highlighting the vast amounts of “dry powder” in the venture market. This should not be a great source of comfort. This “dry powder” is supporting a much greater number of ventures and much higher valuations than in the past. With venture returns likely to significantly fall, investor allocations to the venture space are likely to drop as well, making future VC fundraising more difficult. As a result, funds will be much more careful about deploying their cash and will do so over a longer period of time.
It’s All About the Runway With fundraising more difficult, the gap between success and failure often comes down to the length of your runway – the amount of time before you run out of cash. Runways are generally shorter than most entrepreneurs think. In theory, bankruptcy is an option to avoid paying most obligations, but for reputational and liability reasons, venture firms prefer to guide their ventures to orderly shutdowns. As a result, you will need to set aside reserves to make sure creditors are paid, in addition to legally required tax and wage payments. Fundraising It is easiest to raise funding when you need it least. Going to the market when you lack sufficient funds for next month’s payroll does not inspire investors’ confidence. If you have not raised funds recently, consider accelerating your fundraising timetable, and establish credit lines if you can. Don’t over-negotiate deal terms. Remember – no venture has ever died from excess dilution or suboptimal deal terms, but the same cannot be said for ventures that run out of money. Finally, always have a thorough understanding of your investor base, including which investors are running out of cash. To the extent possible, without damaging the relationship, get a sense of where you stand in your investor’s portfolio – a star who will continue to be funded or a middle-ground player who will be left high and dry. Downsizing the Team Personnel is usually the largest cost for any venture and, therefore, a prime target for extending the runway. In the United States, most venture employees are employees-at-will, so absent a company policy or a specific contractual requirement, an employee can be terminated without notice. However, terminating even at-will employees carries risk, with terminations potentially subject to claims of discrimination based on age, gender, race, sexual orientation and other factors. The best defense for discrimination claims typically is documented evidence of poor performance, so develop sound processes for formal employee feedback and reviews. Unfortunately, in the short term, layoffs may require terminating solid performers. Adding headcount during this period, if at all, should be limited to very high value-add hires. However, there is likely to be a lot of available talent that presents an opportunity for upgrading personnel. Remember that wage payment is not optional. People usually can agree to work for less, assuming that it is above the applicable minimum wage, but once wages have been earned, they must be paid. Failure to pay wages (or taxes) are two areas where officers and directors can be held personally liable if a venture shuts down. Offering equity instead of wages is not an option. Also, employees generally have more termination rights abroad, especially in Western Europe, so consult local counsel. Terminating employees, especially solid performers, is never easy. Have a well thought out process for delivering the unfortunate news and providing the impacted employees with as much support and resources as you can. Real Estate Real estate is usually a venture’s largest and least flexible long-term obligation. When a venture fails, the landlord is often the largest creditor. The first step in addressing this risk is understanding your lease before you sign it and negotiating favorable early-termination and sub-lease clauses. If you are in an existing lease, approach the landlord about potential concessions and do so early, they are likely to receive many requests. The challenge for ventures is that the real estate market is experiencing its own downturn at this time. In this situation, landlords are more likely to hold ventures to their lease terms, creating burdensome white elephants. Even once the current quarantines terminate, ventures should be slow to increase their real estate commitments and the soft market should allow ventures to negotiate more flexible termination and sub-lease clauses in new leases. Suppliers & Customers Critical to minimizing the impact of the current crisis is reviewing the terms of your contracts with suppliers and customers, to understand obligations and ensure maximum flexibility. Ventures should create a database of contract-termination dates and the length of notice required to terminate. Many contracts have automatic renewal clauses that require notice to stop the renewal. The database should also include information about any minimum payment obligations. Expiring supplier contracts should be reviewed through the prism of the slowdown. If you need to cut expenses significantly, will this contract still make sense? Many suppliers will show significant flexibility, to their good customers, in agreeing to modified terms – reduced prices and minimum purchases, and extended payment terms – to avoid termination. Especially in their early stages, ventures often sign marginally profitable contracts to bolster their customer roster. Your response to this crisis should include an analysis of the profitability of each customer, and if you’re downsizing your team, make sure the remaining personnel are servicing the most profitable contracts. For the remaining customer base, contracts should be reviewed with an eye on performance obligations, helping you understand your cost of performance and making your runway calculations more precise. If your customers and/or suppliers include a fair number of startup companies, their continued existence cannot be taken for granted. You should identify second sources to mitigate the risk of supplier failures, become more vigilant about outstanding receivables from at-risk customers, and reject orders from companies whose outstanding balances have grown too large. Now more than ever, ventures should adopt creditworthiness review processes to vet new and renewing customers that are considered at risk. For larger projects, ventures should consider requiring letters of credit from customers to secure payment. Finally, establish lines of communication with critical customers and suppliers. With plenty of bad news in the air, there is a natural tendency to keep the news “in the family.” In the current environment, everyone is hurting and bad news is very understandable. Communicating with these stakeholders will help recalibrate your expectations from them, allow them to recalibrate their expectations from you and minimize surprises. This will enhance the contingency planning abilities of all involved and reduce the potential for future disputes. Insurance In a downturn, investor disputes become more common, increasing officers’ and directors’ exposure, so review your D&O coverage to verify that coverages are adequate for a company of your size. Maintain a reserve for so-called tail coverage. Failed ventures are generally unable to maintain D&O coverage, so tail coverage is necessary to maintain insurance for officers and directors for decisions made while the company was still alive. Preserve Your Reputation Although it may not feel like it at times, there will be a tomorrow. The venture world is relatively small and when this all passes, how you conduct yourself during these trying times will be remembered. Everyone is stressed and confronting difficult choices. Many of these choices will be made in an environment where there are no other options. If you conduct yourself with candor and sensitivity, people will appreciate it and remember when you re-engage with them. Opaqueness and selfishness will also be remembered but in a less positive light. Doing the right thing usually has the added advantage of being good business. Dror Futter is a partner in the Rimon, PC law firm. Dror’s practice focuses on representing startup companies in their financing and merger and acquisition transactions and their intellectual property, IT and internet agreements. He also advises companies with respect to Initial Coin Offerings and other blockchain legal issues. Dror was the co-founding chair of the PLI VC Law program and hosted their first blockchain legal program. He is a frequent speaker and writer on blockchain legal topics. He is a member of the model forms drafting group of the National Venture Capital Association, the legal advisory board of the Angel Capital Association and the legal working groups of the Wall Street Blockchain Alliance and the Digital Chamber of Commerce. Dror can be reached at dror.futter@rimonlaw.com |