Tempest or Nuclear Winter

A Hurricane Ike for Tech Start-Ups

VentureWire Alert (free subscription required) today reported that venture capitalists are advising their portfolio firms to prepare for a potential nuclear winter. One venture capitalist featured in today’s newsletter was quoted as telling firms “to slow down their burn rate, and not concentrate on pushing their valuations up”.

That may be good advice. Let’s go back a bit in the way-back machine and see what lessons we learned from the 2000 tech bubble crash and what startups had to do back then to survive.

Some firms continued to spend like nothing was changing. These firms, for the most part, ran out of venture capital and couldn’t raise more. They failed. A few, with stellar venture backing, kept spending and hoped they’d be rewarded with more market share than competitors who would throttle back marketing efforts during a down economy. I only know of one firm who tried to outspend every competitor during the down economy and they got acquired immediately after the economy improved. The key investors did okay but not great. Don’t try this approach unless you’re absolutely, positively convinced your venture backers will go the distance with you (and don’t be surprised if your equity gets diluted tremendously as these future capital infusions will come in at down round pricing).

Some vendors dramatically scaled back to ride out the storm. Sadly, a miniscule version of a firm will have trouble maintaining market momentum. If your firm is already small, can it really, effectively, succeed as a much smaller firm? The smallest firms may be better suited by putting themselves on ice for the foreseeable future. There are downsides to this approach, though. The most notable of these are that the markets and competition may change dramatically while the company is in the deep freeze. When a firm comes out of its Rip Van Winkle phase, the venture backers may no longer be interested and the solution may no longer be needed or be ‘hot’.

At a minimum, tech startups should: 1) Move all development offshore (if you haven’t already). If you’re going to develop more products, do it the most economical way possible. Some small development efforts may still be cost-effective locally but big projects, in a brutal economy, will quickly exhaust capital. 2) Tie development to new customer sales. Try to get new customers to underwrite the development of new products/functions/services. This is not the time to spend scarce capital on speculative development efforts. If customers aren’t willing to pay for it, don’t build it. 3) Make everyone a salesperson. That means everyone is helping originate and close deals. No one should be above calling on every family, friend and business contact they have to drum up new business. 4) Suspend additional hiring. This one’s obvious. 5) Terminate all marginal employees now. You may have some founders or VIPs (people ‘Vesting In Peace’) who aren’t the world beaters you need them to be. You can’t wait for people to “grow into their role”. Sure, they’re nice but they’re emptying your capital account with amazing speed. 6) Watch out for signs that service personnel are underutilized. If your field consultants are experiencing lower utilization, take action immediately or your business bank account will vaporize. Likewise, see if your product development personnel can take over customer service roles until the economy improves. 7) Defer capital expenditures. Sure, everyone wants new personal computers, Blackberries, etc. but can’t they live with the current ones a bit longer? Every penny spent on infrastructure will cut into payroll. What do you need more: people or gear? Make one decisive cut not death by degrees. Look at the situation honestly. If you think the economy is going to be rough, make one big downsizing decision and go up from there. Do not, and I repeat do not, make a number of cuts over time. It’s excruciating on the work force, demoralizing and sends a never-ending wave of negative news out about your firm. You will never dig out from that PR disaster. 9) Communicate with your board and investors. Listen to their views about the economy, their commitment to your firm and your survival plans. In tough times, expect VCs to circle the funding wagons around a few, big, favorite investments of theirs. Anything else, they’ll leave to the vultures. If you’re not one of their favorites, start planning a more dire future. Begging a VC to be one of their favorites won’t work. 10) Prepare for the option of shutting down altogether. Find out how long your capital runway is and don’t exceed it. Pay your bills and your employees. Don’t get overextended as those personal guarantees, lawyer fees, etc. will kill you in the end. Shut things down the right way. Better still, shut down the business and return unused investment capital. That shows a degree of maturity that VCs may well remember for a long time.

I can’t say whether we’ll be in a nuclear winter yet. But, I’d sure recommend startups take a weekend and have an offsite executive team meeting to plot out their contingency plans. Of this much, I'd bet that valuations will be going down, capital will harder to come by, capital will dribble out in smaller traunches and a lot of marginal businesses and business models will be left to fail. There will be a shakeout.

Good luck.