In this article, we provide a high-level overview of recent developments in the venture capital industry and the action that can be taken by investors and startups to mitigate the impact of the challenges being faced including to preserve liquidity and minimize or avoid short term distress.
Key Observations
- The decade-long tech bull market came to a shuddering halt in 2022, due to soaring inflation and interest rates and lower investor risk appetite with fears of a looming recession.
- Valuations have tumbled:
- Stock prices of listed unprofitable tech companies fell by two-thirds since November 2021.
- Valuations of private startups fell by 56% between 4Q 2021 and 4Q 2022.
- The tech-heavy NASDAQ index fell by a third in 2022, making it one of the worst years on record and drawing comparisons with the dotcom bust of 2000-01.
- Investor caution resulted in the total value of tech investments falling by a third in 2022 compared to 2021, with a particular slowdown in deal activity in 4Q 2022 - the weakest quarter of 2022.
- There are many companies now facing liquidity and potentially solvency issues.
- Despite a market slowdown, venture capitalists raised a record USD160bn in 2022 and there is an estimated USD300bn of “dry powder” available in the US alone.
- For companies to survive and investors to protect their investments, it is essential to proactively address liquidity and funding, operating and capital expenses, maximize cash and working capital, and engage in transparent communication and cooperation with stakeholders to help mitigate the issues currently being faced.
Practical Steps
While there are certain steps investors and companies can take to try and mitigate the VC winter, ultimately the survival of businesses will depend on the status of their balance sheets entering the crisis and the decisive actions of managers now.
A focus on cash is paramount and this will likely require all stakeholders to share the burden. Some key proactive steps include the following:
Protect Your Cash
- Establish a (very) detailed cashflow forecast to monitor and conserve liquidity.
- Where possible, convert existing working capital (inventory and receivables) to cash. Focus on cash and not growth or profit and consider necessity to provide discounts or similar to accelerate sales and cash collections.
- Identify any assets that can be realized in short order to improve liquidity.
- Consider and plan for potential action taken by customers or partners that will impact operations and liquidity. Just as you are, customers will change their behavior to reflect the current economic climate.
- Work with key suppliers, such as landlords, suppliers, employees and financiers to negotiate mutually acceptable amendments to existing agreements based on transparent information.
- If necessary, defer certain payments altogether in the short term until there is increased certainty and engage with counterparties at a later stage.
Access Additional Liquidity
- Establish the appetite for further investment from existing and potential new lenders and investors. Falling valuations may offer an attractive entry point for new equity investors or the ability for existing shareholders to follow their initial investment, but at a much more attractive valuation.
- Consider drawing on any undrawn available funding.
- Initiate early and transparent discussions with shareholders, lenders and if necessary third-party financiers to obtain required funding.
Revise Business Plans
- Focusing on growth instead of profitability or cashflow was appropriate in a world of rising valuations and ample available funding.
- The market and investor priorities have now changed and a bottom-up and top-down review of businesses can identify appropriate measures to cut costs and refocus the business to reach profitability in a shorter timeframe.
- Develop a medium/long term cashflow forecast to demonstrate the viability of the business and to assist in attracting further funding.
- Identify key management/employees that are essential to the ultimate success of the business and ensure they are retained and remain motivated.
- Provide revised employee incentives, particularly relevant where the value of previous equity awards has recently fallen (potentially materially) in value.
Review Reporting and Governance
- Many startups have room for improvement of their governance and reporting structures, these functions become even more important in times of stress.
- Reporting and governance structures should be reviewed to identify any simple and effective changes to maintain and improve investor confidence, which is of utmost important during times of market turmoil.
Early and Proactive Communications
- Transparent, early and regular communication with stakeholders is critical to obtaining the support required to meet the impact of the banking crisis. Key examples include:
- Asking key suppliers and landlords for short-term relief on payment obligations
- Flagging that certain covenants or payment obligations will be breached on banking facilities and collaboratively working with lenders to restructure facilities
- Working with employees to reduce leave balances, defer bonus payments and temporarily reduce hours or salaries in order to avoid redundancies
- Giving notice to key creditors that you simply cannot make an upcoming payment obligation but wish to engage to come to an agreement on how you plan to rectify this.
- Businesses will not see benefit unless dialogue remains open and companies are able to demonstrate the steps being taken to minimize stakeholder risks and a long-term path to maintain solvency.
Kroll Restructuring Solutions
Businesses around the world face uncertain times. We understand the challenges and help management teams, directors, shareholders and lenders identify new paths to growth and enhanced profitability. We provide practical guidance and hands-on support that maximizes value for our clients.
When time is of the essence, we work at speed and take effective decisions to deliver results. Our team is agile and entrepreneurial, combining restructuring and turnaround expertise, with deep sector knowledge and market understanding to manage each unique challenge or situation.
We devise action plans that immediately help catalyze business change and accelerate growth, including strategies to attract investment or maximize revenue opportunities. We provide businesses and their backers the operational and financial tools they need to drive value and succeed.
How We Can Help
- Operational and financial restructuring and turnaround solutions
- Independent business reviews
- Risk management assessments
- Strategic business repositioning
- Cash flow management and profitability enhancement
- Debt and capital structure guidance
- Business blueprints to attract capital and maximize value
- Crisis & interim management (Chief Restructuring Officer) – Executive Appointments
- Independent Financial Advisors and Monitoring Accountant
- In-and out-of-court workouts
The Kroll team has significant experience assisting distressed clients internationally. We would be happy to discuss how our approach can assist your firm.
Sources:
https://www.economist.com/business/2023/02/26/how-the-titans-of-tech-investing-are-staying-warm-over-the-vc-winter
https://www.economist.com/finance-and-economics/2023/01/18/venture-capitals-300bn-question
https://www.economist.com/leaders/2023/03/02/the-tech-slump-is-encouraging-venture-capital-to-rediscover-old-ways
Disclaimer: The information in this article is of a general nature only. The information given does not take into account your particular financial situation or needs. Therefore at all times you should seek appropriate the advice before you act further.
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