Saturday, 9 February 2008

Grab an umbrella - a storm is brewing



Let's face it. We are heading for a tough year for start up businesses. The slow down hasn't hit hard yet and it may not hit at all but I am betting that it will, and any smart tech start up guy will be thinking the same way.

You can see the signs. Wobbly house prices. Tightening consumer credit. Slow down in tech spending. Balance of stories in the business media shifts to negative. There is nothing new here, we've seen it before, we know how it plays out and we know how to survive it. Remember 2001-2002? Ouch!

The conversations that I hear as CEO of Garlik today are almost identical to those I heard as CEO of my previous tech company in 2001/2. For the first few months everyone pretends it's not really happening. We all say "oh, yes, there are some macro trends but it isn't impacting my business". The ever optimistic entrepreneurs all have some argument about how their unique value proposition will be unaffected. In fact, it may be true that business is really good and may even feel like it is accelerating (you know like those cartoon characters whose legs whizz round really fast when they've just run off the edge of the cliff, before gravity takes hold). IT Directors at big companies smile knowingly and explain that spending plans don't change that quickly and its business as usual. VCs claim with confidence that there is a wall of money desparate to be invested and good deals always get funded so everyone should calm down.

But when it turns bad, it turns quickly. Everyone catches a cold and the tech entrepreneurs who don't understand what's going on or are slow off the mark get hit hardest.

Here's what happens.

Executive Committees in the big companies start to have conversations internally. Externally they say "business as usual" but internally they just start to tighten things up a bit. I've been an IT Director, I've sat on those exec committees. I know how it works. Your Finance Director has "a word". The IT Director sends out the message to his guys that it's time to think a bit harder before signing stuff off. No major cuts (yet) but the guys get the message and pass it down the line. Project managers become a bit more cautious about giving the go ahead. They hold a bit of budget back for when the cuts come (hey, they can always spend it later after all). They lean away from small tech companies because if a downturn does come they don't want to be left doing business with a bust start up company, however clever its technology. Besides, the technology will still be there in a years time so what's the hurry?

Tech start up companies selling to these guys hardly notice that things have changed. Sure, meetings take a bit longer to set up, but they still happen. Nothing on the sales pipeline goes away, it just gets a bit sticky, like walking through treacle. Decisions are not quite getting made, but "hang in there, we are still very, very keen" is the message that the tech guy is given by the client. Decisions that previously had to be made urgently before the summer for "time to market" reasons seem to drift towards the autumn. Everything drifts to the right. Have you noticed it yet? Watch and watch very carefully.

The VCs keep looking for deals and if asked they say "sure the economy looks shaky but nothing has changed on our side". But the more experienced guys in the investment committees know what to do and they start to guide things behind the scenes. Keep the deal pipeline full, keep looking at the new deals but don't be in a big hurry to green light anything. Talk in terms of more agressive pricing but don't indicate that deals may actually not get done. Don't be the first in the VC community to pull the plug. Doesn't make you look good. But read the signs across the portfolio carefully. Are we seeing all the pipelines drift to the right yet? Are exists going to take 12 months longer? If yes, then let's hold on to our funds because there's a lot of financing of existing companies to be done yet.

When all this watchfulness is going on, you know you are at a critical point. This is the stage we are at now, from what I see and hear. One or two negative events can trigger the next stage and then things move quickly.

Companies move first. They trim their budgets back by 5-10%. Not much in the grand scheme of things, but actually that means they trim their innovation budgets back by 50-100%. The "new stuff" grinds to a complete halt, even if it's just for 6-12 months or so.

The impact on the tech guys is harsh. Pipelines that looked really solid just a month or so before vanish completely. 12 month sales cycles become 24 month sales cycles. Base case predictable 2008 revenues suddenly halve and even halve again. Monthly cash burn leaps and suddenly hundreds of tech start ups have an unexpected funding requirement in the next few months rather than over the next couple of years.

But just as that widespread funding requirement emerges, the VCs shut up shop to new business. It's not a question of the price of deals, it's that the door practically closes to new deals completely. All the VCs look internally. They look at their own, existing portfolios and keep their (financial) powder dry in order to ensure that their existing companies survive this coming difficult period.

So, if this rather bleak scenario turns in to reality, what should a tech start up company do? First and most important "Don't Panic". It can be ridden out, but it requires smarts and discipline.
Firstly, take a hard look at your 2008 budget and run the following scenarios. What does it look like if you get (a) 50% and (b) 25% of the revenue you are expecting in 2008? You don't need to cut costs immediately but you need to know exactly when and how to cut costs if you find yourself in (a) or (b). No guess work. Just plan it out.
Secondly, keep your current cost base tight. Were you thinking of taking a slightly larger office as you are a bit cramped? Don't. Sit tight. Were you going to add one or two extra staff just to ease the pressure? Don't. Sit tight. Do you still fly business class? You fool. Get back in coach! You don't need to go crazy on costs, but you just keep everything nice and tight for now.
Thirdly, raise cash now. Right now. Put cash in the bank, even if it looks like costly money that you might not need. Do you really want to be out raising money along with several hundred other desparate start ups in 6 months time? Don't get fancy on terms and valuation - in a downturn cash counts and everything else is just noise. You want to make sure that in a scenario where you get 50% of your expected revenue for 2008, you still have enough cash to last you a good 12-18 months, and that even if you get 25% of your expected revenue you will still last 9 months and have time to make the rapid cost cuts you will need to.
So, grab an umbrella, a storm is brewing. But, hey, we've seen it all before. And sooner or later, the sun shines through, the rainbow comes out, the rubbish has been washed away and the real entrepreneurs are still standing and smiling. See you there :-)

1 comment:

Benjamin said...

Those are wise and practical words, from an experienced voice.

On a brighter note, a start up that weathers the storm is usually stronger that one that has not.

As you say, the wheat gets sorted from the chaff. Businesses are about solving customers problems. If you are solving the right problems, there is a business.

Hard times change the rules, weakening incumbent players and creating new opportunities for the small and nimble guys.