Turn on the TV or read the business press and you’re likely to see another article suggesting we’re in the late stages of another startup tech bubble (some examples: Startup Diving, Business Insider, Fortune, Fox Business).
Arguments for this include everything from venture capital valuations, to companies emphasizing customer acquisition instead of having a clear path to revenues. For a while there, the tech heavy NASDAQ was out of control with internet firms sporting excessive Price to Earnings ratios.
I’ve already experienced three down cycles of varying severity for the tech industry (1991, 2001-2002, 2008-2010).
My take? I don’t think we’re quite there yet, but it could happen. Even if the tech sector isn’t in an extreme bubble as some might predict, every industry goes through business cycles and at some point the tech sector will encounter one. Its best to know where your business stands and have a contingency plan for a down cycle.
Here’s the 5 keys to strengthen your company and ensure survival in the event of a down business cycle
1) Customer Willingness To Pay (Enough)
This business cycle saw an emphasis on ‘freemium’ business models (give a product away for free and charge for additional features). During a tech boom, investors are patient and may be willing to let you grow without worrying about having a clear monetization strategy.
However, during a down cycle, investor patience will start to dwindle, capital becomes more scare and your company will need to rely on paying customers to stay in business. If your current customers are paying for your product, great. Take it a further step to see if you have pricing leverage. Perhaps many customers would pay more than you currently charge (and generating more margin dollars)?
If customers only want what you offer for free, you’ll need to look long and hard at your current products and company competencies to find what they’ll actually pay for.
2) A Scalable Sales Model
You need to know the cost today to acquire a customer and how that changes as sales ramp. As demand picks up, your marketing and sales expenses should ‘scale’ (cost per sale decreases as volume increases), a key part of attaining profitability. If the data suggests your sales expense isn’t scaling, you need to re-work your current sales process or find new, more efficient, channels of distribution.
3) Understand Your Cash Flow
OK, so you’ve ensured you have the right product and working on improving your cost of sales. Now, you need to examine your new ‘burn rate’ and find out if your cash flows are sufficient to ride out a down cycle. Take your business plan and start to factor down your revenues and look at the impact of your fixed costs.
If your fixed costs start to drag down the security of the company’s finances, its back to the drawing board. You’ll need to either figure out ways to increase revenue or cut costs (including restructure your headcount). While laying off people isn’t fun, fact is you owe it to your shareholders to be efficient with their capital.
4) Ensure Plenty of Working Capital
In addition to cash flow, maybe now is the right time to raise additional working capital. One option is to open up lines of credit based that can give you cash flow flexibility for tough times, for example if your customers start paying you late. Another option is to take advantage of the current, liberal investment environment to raise additional capital, rather than wait for when capital is more scarce and comes with more difficult business terms / impact of valuation.
5) Make Sure You Have Strong Relationships With Potential Partners and/or Acquirers
When seeking large partners or negotiating an acquisition, you have most leverage in a great economy or when you’re on the top of your category. That said, if timing isn’t on your side, you absolutely need to know what companies you’d look to partner with or look to engineer a sale with. Just like raising venture capital, acquirers tend to deals with companies they’re familiar with and have thoroughly researched. Ask your self – do these companies know you exist? Do you have strong relationships with them? If not, time for your CEO, CFO and head of Business Development to get to work and start to build these relationships. If its not already apparent, these relationships have a direct impact on the value of your company and your investors / board know this.
In closing, it may seem like a waste of time to think about these issues while the economy is red-hot and capital readily available. Business cycles are regular and eventually your business will be facing tougher economic times. Spending a few hours a month with your management team to deep dive into this scenario has real value to you and your shareholders. At a minimum, you’ll engage in a team building exercise which gets everyone thinking about how the business operates and focus on delivering shareholder value. At best, you’ll have contingency plans and an understanding of how to succeed in a down business cycle.