Cash is King: How A Capital Strategy Can Enable Today’s Startups to Survive

Client Alert

2023 has proved to be challenging for many cash-conscious startups, especially those that anticipated raising venture capital in the first half of the year. As the Federal Reserve continues to increase interest rates in an effort to curb high inflation, the public market pullback, especially in the tech sector, and fears of a looming recession have made many investors hesitant to deploy new capital. Such fears have largely quelled the pandemic era of high valuations and easy access to cash for startups. During the “good times” of the past few years, many startups (including those with relatively limited track records) and their founders were able to access venture debt to bolster balance sheets and extend cash runways without the dilutive effect of raising investor money. However, the recent bank failures have significantly impacted the venture community, threatening to upend access to venture debt facilities. Although there are a few bright spots (like artificial intelligence and climate tech), with private company valuations falling and lower availability of venture debt, we expect startups will need to further preserve cash and resources to navigate the expected continued rocky terrain ahead. Here are some measures that startups should consider in the near term:

Clear Cash Flow Projections

Startups should optimize their balance sheets and scrutinize all accounts receivable and accounts payable. Startups should send routine reminders of all outstanding debts to any customer who is delinquent on payments and should do so until such debts are fully paid. To the extent possible, companies should ensure that all accounts payable are paid on time and in full to avoid any unnecessary late fees or interest payments. Startups should make sure their financial systems are accurately capturing all transactions to ensure the management team can make financial decisions confident in the fidelity of company cash flow and obligations. Further, companies should take a conservative approach when modeling expected cash flow projections over the next few months or quarters. These steps will allow a company to get a true understanding of its current cash position and help provide clarity on what can be scaled back, if necessary.

Reduce Cash Burn

Startups should look for ways to reduce their monthly spend and extend their cash runway. Companies may want to consider the following:

  • Remote Work: Consider whether it is important for the business that the team be in a central location or whether a remote workforce or a hybrid of both makes more financial sense. The pandemic has proven that, in some instances, a remote workforce is more efficient and cost-effective than a workforce that reports to a central location on a daily basis. Commercial rents are expensive, especially in big cities, and oftentimes drive up a company’s budget. Removing expensive rents from a company’s budget could be a pivotal cash-saving move. Of course, startups will need to weigh the impact of going remote on company culture and measure any financial (and nonfinancial) costs associated with shifting to a remote workforce. Many fully remote companies have increased company off-sites and other gatherings to preserve company culture. The costs of these events are sometimes not well understood when a company decides to shift to a remote workforce.
  • Review Critical Talent Needs: Assess staffing needs and determine which positions are absolutely critical to maintain business operations. Consider scaling back positions that are not critical to the business and/or reassigning employees to duties that are more impactful to the business. Companies may also consider (i) renegotiating employee compensation and offering employees more equity and less cash compensation (which many startups are already inclined to do), (ii) moving some employees to a part-time schedule, (iii) furloughing noncritical employees for a period of time as the company navigates the current economic conditions, and (iv) laying off employees in noncritical departments. Of course, companies should consult qualified legal counsel before undertaking these steps to ensure compliance with the myriad of applicable employment laws.
  • Minimum Viable Product: Companies may also need to consider whether it is possible to bring their products to market faster than anticipated. Adopting a product iteration approach to product launch is well-worn territory, especially for tech startups, and having a working product will help balance sheets if early customer adoption can translate into early revenue.

Potential Sources of Funding

It is important that startups maintain frequent communications about their progress and financial position with current investors. These investors are already incentivized to help the company as they have a financial stake in the company’s survival. Investors may be persuaded to inject fresh capital to extend the runway of a portfolio company they have strong ties to and may ask peers to do the same. These same investors may also have other suggestions that could be helpful, and/or make introductions to potential customers or investors. Companies can also extend their cash runway in the near term by obtaining funding from conventional or alternative sources, such as those detailed below.

  • Extensions or Flat Rounds: Startups may consider extending the terms of their last round or even doing a new round at the same price as their last round. While this would dilute current shareholders, it may be a viable option for companies that need to shore up their cash positions.
  • Bridge Rounds: Startups should also consider bridge rounds of financing. A Simple Agreement for Future Equity (SAFE) or a Convertible Note could be a path to a quick cash injection with relatively low legal fees. SAFE and Convertible Notes have fewer terms to negotiate with investors, thus reducing the negotiation time and also allowing companies to delay setting a valuation on the company (which is often the subject of much negotiation).
  • Venture Debt: While some of the most prominent and well-known venture debt lenders have pulled out entirely or scaled back their venture loan activity, there are a number of other banks that offer venture debt services for startups that could be explored, and new product offerings seem to be popping up from other lenders on a regular basis. Companies are well advised to speak with their banking partners, legal counsel or financial advisers to understand what options may be available.  
  • Government Grants: There are a number of research-based government grants that startups can apply for that can potentially provide a necessary cash injection. Some state governments, such as New York, have recently announced programs that provide matching investment funds for startups that qualify (Pre-Seed and Seed Matching Fund Program). Similarly, certain financial institutions have pools of capital targeting underrepresented founders and communities.
  • SaaS-Based Lending: Companies that sell software as a service (SaaS) can also apply for SaaS-based loans from nonbank lenders. These nonbank lenders allow companies to borrow money against recurring revenue streams and generally are nondilutive.

In the event that the current economic challenges remain constant or worsen over the next few months, many startups may be forced to take more austere measures. Negotiations between companies and investors will lengthen, and investors generally will be able to demand more investor-favorable deal terms. Before initiating any of the options detailed below, companies should consult qualified legal counsel and determine whether any investor rights (e.g., blocking rights, voting rights, anti-dilution triggers, pro rata rights of others) are implicated or triggered by these options.

  • Extended Financing Rounds: The time between financing rounds could be longer than before, as investors may require (i) stringent diligence and have less tolerance for deals outside the investor’s risk parameters, (ii) stricter (i.e., less company-favorable) deal terms, and (iii) lower valuations. Whereas in 2021 a company may have been able to close a Series A financing within one to three months, that same round may now take between three to six months.
  • Down Rounds: Companies may need to consider new rounds of financing where the pre-money valuation is lower than the post-money valuation of their prior round (known as a “down round”). Startups generally try to avoid down rounds because the lower valuation may imply that investors have lost confidence in the company and because investors are frequently protected from down round dilution. However, in some instances, a down round could be beneficial and may be a sacrifice that some companies and investors are willing to make to better the company’s chances of surviving.
  • Consolidation: In times of economic uncertainty, many companies will consider consolidating with competitors to gain better market efficiencies and to ensure future success. A merger or an acquisition could be beneficial for startups whether they are being acquired by a larger company that is better positioned to weather a financial downturn or merging with another startup in their space to share cost. Companies that need additional funding should identify their well-funded competitors and consider approaching them as an acquisition target, and well-funded companies should reevaluate the opportunity to target companies with interesting technology (or talent) with favorable valuations.
  • Pivot or Wind Down: The unfortunate truth is that, even under the best economic conditions, most startups fail. Some startups will exhaust their cash reserves and be forced to suspend all operations and wind down. While this is not what founders and investors wished for the company, if identified early enough, it could be an opportunity for founders to pivot and redouble efforts to find product-market fit. Of course, some startups may be better served by shutting down completely and returning some of their investors’ money rather than attempting to make a hard pivot and restarting the search for product-market fit.

Startups will need to implement elevated cash management, capital raise and exit measures to withstand the current market tumult. Companies should fully understand their economic position, scale back where possible and frequently communicate with investors. Making decisions early, before the situation is critical, will often result in a better outcome. We know the terrain will be rocky, but the companies that can extend runway and lower their cash burn may be in the best position to survive.  



pursuant to New York DR 2-101(f)

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