This is a copy of the letter we sent to our founders and CEOs in early March 2020.
Hi Portfolio Founders and CEOs,
In the last few weeks, we have seen an unprecedented level of discussion on the likely implications of COVID-19 (Coronavirus). Like everyone, we are nervous about the possible terrible consequences for our society. While predictions abound on the likely impact and duration of this outbreak, we are going to take the advice of Liverpool Premier League manager Jurgen Klopp and not comment on areas where we have no expertise. We do, however, want to share an insightful quote from Paul Graham of Y Combinator: “With exponential functions, you want to err on the side of caution.”
We thought it worthwhile to share some observations we’ve made on leading companies through a crisis or economic downturn.
We also have an overriding message that our job is to work with you and support you through this crisis. We are here to help you in any way we can.
First and foremost, keeping your teams safe and healthy is of paramount importance. As is safeguarding the health of anyone who may interact with your organisation. Many of you have already shown leadership by adopting best practice measures to reduce personal risk.
We expect that each company will have a policy tailored to their needs based on their size, geographic location, number of office locations and other factors. We urge all of you to have policies in place, including a policy dealing with business continuity in the most extreme situations.
If you are yet to implement a policy, below are exemplary examples from organisations we admire (not published here as they wished to remain private).
In any crisis, your team is looking to you for leadership. Leaders show leadership in different ways, but in our experience, there are two crucial commonalities. Leaders don’t panic, and they don’t bury their heads in the sand.
They show empathy and understand that people react to situations like this in different ways. It is okay to admit you don’t have all the answers. Your teams don’t expect you to have suddenly become an expert on epidemiology. You must, however, communicate. Be there to support your teams, focus as much as possible on the things within your control and, within the obvious constraints, pursue your mission with as much ambition and normality as possible.
Understand the business impact
We expect this crisis to affect your businesses differently. Some of you are already feeling the impact, and some of you aren’t, yet. We encourage everyone to be doing scenario planning on possible impacts and identifying what actions you might take in response.
Our general advice is that in these situations, the impact will frequently be worse than you anticipate. What seemed a certain sale might fall over at the last minute, limitations on travel might impact on your ability to win new business, productivity may fall off a cliff, team morale may dip and new products might ship late. We need to be aware that we could well be headed for tough times and preparation is critical.
We also encourage you to think about both direct impacts and second-order impacts. Irrationality will also play a part: who’d have thought that Australian’s would have panic-bought toilet paper to the point of bare shelves. What are the “toilet paper” examples in your business; what are the implications that are both not immediately obvious and which may have a severe negative impact on your business.
Cash is king
There is only one ironclad rule in startups; don’t run out of money. None of us know how long this crisis will last or how severe it will be. What we all know is that investors hate uncertainty, and it can be difficult raising capital in uncertain times. It may be that there is more clarity in a few weeks, but equally, the level of uncertainty may be greater.
Most of you have raised money in recent months and are well-capitalised. Some of you are currently in the middle of processes or will be kicking off capital raising processes in the next few months. In extreme cases, investors stop investing new capital. In less extreme cases, it gets harder to raise capital and valuations can be impacted. We haven’t seen evidence of an investor “strike” yet, but it is impossible to predict the future in a fluid situation like this. Consider your unique circumstances and capital needs.
There is a broader point here about capital raising that we need to remind ourselves in good and bad times constantly. It can sometimes be tempting to delay raising capital to the last possible date and have a bias for raising a bit less rather than a bit more. This strategy works when everything goes to plan; if your business grows in the way you expect and if there are no external crises, then this approach will work fine. However, all of you have worked too hard and created too much value to risk everything by assuming that everything will go to plan.
Raising capital involves a massive level of asymmetrical risk; if you raise a bit too early or raise a bit much then the downside of more dilution is known and finite but if you raise too late or something goes wrong with the raise then you are risking your entire business.
Balancing the long term versus the short term
An economic downturn or a crisis can be a time of enormous long term value creation for startups. If you are well capitalised and make strategic long term decisions, then you can be incredibly well placed when we emerge on the other side. The impact of a downturn is usually one-off (albeit the period of a downturn can vary significantly), however, if you use a downturn or crisis to strengthen your position, then the benefits are permanent.
A few things might happen during a downturn:
customers may be more inclined to move from higher-cost incumbents to startups offering a cheaper alternative,
customer acquisition costs may come down,
there may be a reduction in irrational competitor behaviour
poorly capitalised competitors may disappear.
The goal for all of us should be to emerge from this crisis in a stronger position than from where we started.
Great founders focus on the long term but don’t ignore the short term and or the external environment. It may be appropriate or prudent to make some decisions that preserve cash. That will be particularly true if your business is likely to be significantly impacted by Coronavirus or if your cash position is tight. You might need to freeze hiring, reduce marketing, cut other discretionary expenditure or in more severe cases reduce team numbers. Our general perspective is that you should look to cut costs now if your cash position is not super strong and if you can’t ride out a protracted downturn.
If you are in a strong position financially, then you are well placed to “invest” through this crisis. However, we know that in all businesses, there is likely inefficient or unnecessary expenditure. In this environment, it is a great time to identify areas of inefficiency that will enable you to save cash without in any way impacting your future growth prospects.
Founders understand exponential growth so as a group, you are well placed to conceptualise the possible implications of Coronavirus.
We are so grateful to work with such an exceptional group of founders. We urge all of you to be cautious, focus on the things within your control, support your teams and lean on us as much as possible. We regard all of you as part of a big extended family and wish all of you and your families and teams well.
Best, The Square Peg Team