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Cash Is King

29 October, 2008

Jolly’s Volley: So the world seems to be falling apart around us (at least in the economic sense) and the preachers are preaching about doomsday and the followers are buying into that scenario in a big way. What is an entrepreneur to do in this situation? Although I can’t claim that I have lived through several cycles so I know the exact prescription, but there were a handful of lessons that are applicable in today’s environment as they were in 2001 in Silicon Valley. Here are my top ten tips.

1. Sing it with me…”cash is king, cash is king, cash is king”. And that’s coming from a Singh. As an entreprener you can afford to run out of some things, but never run out of cash. As I am telling every one of DFJ’s portfolio company CEOs, cash is a prerequisite for survival, and survival is a prerequisite for thriving.

2. When offered cash, take it: This one may seem the same as #1, but is very different. Entrepreneurs, by their very nature, are optimists. They have to be since the odds of survival are usually against them. But that optimism can hurt in certain situations. Especially in times when cash it tight, some entrepreneurs and especially first time entrepreneurs, have a hard time believing that the valuation being offered for their company by investors is some fraction of what they themselves believe it ought to be. For example, one might think the company is worth 100 Crores, but the investor has issued a term sheet at a valuation of 40 Crores.

The knee jerk emotional reaction is to simply walk away from the offer, given the difference between expectation and reality. Thinking on the part of the entrepreneur is to delay the financing since with additional time, his/her company will make progress and therefore the valuation will naturally increase. I predict that the landscape, both in India and the US will be littered with companies that should have taken cash at a lower valuation some weeks ago but didn’t and have run out of cash. In a downturn, or when the time to raise capital increases, don’t haggle on valuation.

Perhaps take a little less than what’s ideal to reduce dilution, but enough so that you can get through the next 18 months, at least perhaps by being more capital efficient. Also remember that anything that involves getting cash in the door will take a lot longer. Fundraising that might have taken 3-4 months might now take 6-8 months; receivables will get delayed; bank debt or lines of credit from those who are still willing to lend will take a lot longer to get in place.

4. Capital efficiency: During hard time, capital efficiency is a mantra that should be internalized to the point of being part of the employees’ DNA. One has to do more with less. That means looking both backward and forward. Backward, in the sense, that one has to scrutinize every expense line item that has been part of the historical P&L statement. One should start with the larger items (salaries, rent, marketing etc.) but not ignore the smaller items (meals, entertainment etc.).

Once the expenses are truly understood, the entrepreneur needs to move very quickly to cut costs going forward. Knowing the all forms of cash (debt, equity, revenues) may be tight, the company has to bring its burn in line with reality. Once the culture of capital efficiency gets internalized during the difficult times and the company as a whole starts focusing on cash, profitability and operating margin, that culture carries through during the good times resulting in much better financial and operating results.

5. Cut deep and cut fast: I have already alluded to this, but during tough times, very difficult decisions need to be made. People have to be laid off because startups simply cannot support the overhead if revenues shrink and capital is not accessible. As a Board member, it might be relatively straightforward for me to say “cut the burn by x%”, but the actual act of letting people go is emotional. There are people and livelihoods involved. The act of Reduction In Force (RIF) is one that actually involves a fair bit of planning.

The CEO has to make sure that the RIF is conducted in a manner that has the least amount of disruption to the business, operations and most importantly morale. One who can do it successfully, can actually turn a potentially disasterous event into a “rallying cry” for the troops that are remaining.

If the reasoning for the RIF is explained properly, the troops will buy in and actually become a more committed closely-knit team determined to have the company make it through the downturn. The decisions also have to be made sooner rather than later. Most importantly, the RIF should be deep without destroying the company. If people get laid off in one wave, it is difficult and emotional but companies recover from it. If people get laid off at regular intervals, then morale never has a chance to recover and employees are constantly worried if they might be next to be let go.

5.  Men and the boys: I often state that it’s times like these that differentiate the men from the boys and the real entrepreneurs who has infectious passion and zeal from those who are “opportunistic” in nature and run for the hills when the going gets tough. During good times, it’s relatively easy to raise capital, especially in a market like India where quite honestly considerable venture capital has been raised, but relatively speaking, there are few high quality deals. During bad times, I actually look for entrepreneurs who tend not to worry about the climate but about addressing the opportunity that they honestly believe in.

6. Renegotiate everything: Remember that everyone is being impacted in this environment and almost everyone is willing to negotiate, from service providers, landlords to hotels and taxis. I recently stayed at a decent hotel in Mumbai and ended up negotiating a 20% discount to the already reduced Internet only rate. The downside is that I found myself on the other side not too long ago, when a portfolio company had their valuation cut in half after the term sheet had been signed and we were close to getting the transaction completed.

7. Great time to take market share: Although people tend to get engrossed in all the negativity during a financial crisis, there are also several positives that present themselves. This is a great time for entrepreneurs to take market share from competition, especially if they have a bit of capital. Competitors may clamp down on spending altogether and there will be few “me-too” competitors during hard times. Be creative with your marketing and use PR as well as your customers and partners as evangelists for your product or service. Spend on product development or building key features/functionality that will lead to differentiation downstream.

8. Hire key employees: This may seem contradictory to the idea of RIF that I mention above. But this is also the perfect time to bring on key hires to strengthen the company. Compensation expectations become more reasonable and a sense of loyalty sets in, even in India where there is a culture of island hopping from company to company every six to nine months.

9. Stay off the media: We live in a society that is infatuated and inundated with media. And media generally thrives on sensationalizing the bad news. Even if one is an optimist, after being pounded day-in and day-out with bad news, mind and body go numb. Instead, one should stay off too much media and focused on the business. One can either moan and groan about the economy and the downturn, or live with the hand that has been dealt and try to make the most of it. Remember, focus on what you can control (costs, company culture, product development) but not on what you cannot.

10.  Be creative: I will end with what I started with. Cash is indeed king, and one has to be do twice as much with the same amount of capital. Those constraints require a different mindset and true “out of the box” thinking. That might mean laying off the entire team except for 2-3 people to simply survive, do consulting gigs to keep the cash coming in, but work nights and weekends on the products until the environment improves.

It might mean moving in with parents or friends, cutting your personal costs so that you can defer your own salary to make the cash last longer. For those employees who might not be as cash strapped, it might be a time to do a stock for cash deal whereby if they give up their salary for six months, they are given equivalent amount of company stock.

Remember also that it’s not a bad idea to be an early stage startup in this environment because timing may work in your favor. This might be a perfect time to be developing a product or service rather than selling it (since customers may not be keen to buy from startups) but by the time the product or service is developed and refined, the timing and the customer sentiment may be just right.

Bottom line: There is no doubt that times are tough, especially for entrepreneurs who are trying to raise capital. But by cutting costs, being capital efficient, being realistic about valuations, focusing on what one can control (rather than external uncontrollable factors) and realizing that cash and survival are paramount, they can best position their companies to not only survive the downturn but do well when the positive sentiment returns.

I am convinced that 6-7 years from now, we will all look back at late 2008/early 2009 and realise that some great companies were created at this time. And I certainly hope to be part of a couple of them.


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