Startups Must Get Creative to Extend Their Runways

The Bull Run for VC-Backed Startups is Over

Whether through their own product offering or by applying pressure to incumbents, over the preceding decades, startups have served as the catalyst for technological innovation. The VC funding model, bolstered by foreign capital and accelerated by low interest rates, has done an excellent job in fueling this explosive trend. Seemingly limitless funding rounds have allowed founders to focus on growth, often leaving unit economics or profitability as an afterthought. This model has brought us titans like Uber, WeWork, CrowdStrike, companies who leveraged ever-growing valuations to buy market share.

Startup Capital is Retrenching

Forecasting RevGen uncertain as consumer and business spending habits change

Enter COVID-19. The pandemic and resulting economic contraction is putting major strain on this model. On one side, the growth forecasts that startups use to generate their valuations and raise capital are being thrown out the window— despite many states reopening, it’s safe to say that commerce will not simply snap back to what it looked like in 2019. On the other side, the speculative capital supplied by VCs is going through a reality check and contracting as well. With a pull back from investors and uncertainty around revenue generation, many startups are looking toward alternative funding sources to bridge the gap.

The startup scene has seen a strong fundraising environment in the last six years, with VC funds raising $35B or more annually since 2014. Logic (and history) tell us, however, that investors tend to pull out of higher-risk illiquid asset classes in times of uncertainty— VC fundraising fell by almost 60% in the first years of the great recession. VCs aren’t immune to market cycles and will face pressure from their own funding sources as LPs rebalance their portfolios, some reevaluating (or pausing) their fund commitments until they see where the dust will settle. With that pressure, VCs are reevaluating how and when to deploy capital.

Business as we know it has slowed significantly. Both consumer and business spending habits have changed in the short run and larger shifts in spending can be expected in the medium term as the pandemic shuffles priorities and accelerates digital transformation. What was a suitable product market fit in January is not a suitable product market fit in May, and (as much as we think we can see the future) is uncertain to be a fit in September. Growth stage startups may be feeling the most stress as their existence is tied so heavily on being able to deliver on growth forecasts. They don’t know when the dust will settle, but they need runway until they get a better idea of what the other side looks like.

Extending the Runway at All Costs

Cost cutting and a turn to alternative finance

There are some consistencies in what is being done to extend runway among Silicon Valley startups. Driven by strong guidance from their backers, founders are on a cost cutting mission. As of this writing, 450 US startups have laid off over 60,000 employees. Teams are looking to reduce infrastructure spend while founders are taking pay cuts. But you can only cut expenses so much without sacrificing any hope of growth. On the inflow side, some startups are attempting short term pivots [like Airbnb’s virtual travel experiences] in hopes of capturing some revenue.

“Crises and deadlocks when they occur have at least this advantage, that they force us to think.” – Jawaharlal Nehru

Without the option to raise more Venture Capital, startups are increasingly turning to traditional and alternative lending markets. A startup’s likely first stop is the bank. However, with their limited operating histories and uncertain cash flows, the backward looking nature of a bank product is not a good fit. Alternative financing options that leverage assets such as real estate or equipment— a next stop for businesses undergoing stress— are often not an option for startups at all due to their asset-light nature.

However, for enterprise facing VC-backed companies there is a beacon of light. LSQ’s Invoice Financing Program is a creative option that allows startups to leverage their commercial accounts receivable to accelerate cash flow. Unlike Venture Debt or other cash flow style products, Invoice Financing is a flexible source of capital with no monthly repayments, covenant-light contracts, and a non-dilutive structure— we never take warrants. With over two decades of experience we understand the complex nature of working with your VC and act as a trusted partner to provide comfort for all parties involved.