In early March, noted Silicon Valley venture capital firm Sequoia Capital warned of a drop in business activity, supply chain disruptions and travel curtailment. The message aimed at investors, but also true for startups, was brace yourselves for turbulence and have a prepared mindset for the scenarios that may play out.
Similarly, the March 22 edition of The Weekend Pitch anticipates a decline in Private Equity (PE) buyout activity with debt financing becoming more difficult to obtain, possibly accompanied also by PE redirection toward investment in distressed assets.
During this current COVID-19 turmoil, equity funding for startups and small businesses will likely diminish, as it did around the 2001 and 2008 financial downturns. Even though this time the federal government proposes to expand Small Business Administration (SBA) lending, SBA loans may not be an attractive, or even viable, alternative for many organizations. In addition to possibly requiring personal guarantees, each principal owning 20% or more of the company, each general partner or managing member will be required to provide tax returns and personal financial statements. In any case, increased principal and interest payments may ultimately exasperate cash flow problems, while potentially jeopardizing personal finances of loan guarantors.
What are some practical alternatives for addressing sudden cash flow challenges, absent attractive debt or equity financing alternatives?
On the billing and collection side of the business, here are some suggestions:
Identify any unbilled work.
Professional services firms and other businesses often struggle from the adverse cash flow impact of performed but unbilled services. Review of the balance sheet may show such items classified as unbilled revenue, work-in-process (WIP), or revenue recognized in excess of billings. If so, action should be taken to identify such amounts and issue related invoices as quickly as possible. Without an invoice, the customer cannot begin processing your payment.
Address with customers possible restructuring of payment terms and milestones.
It doesn’t hurt to ask well financed customers (especially those with whom your organization may have a long and successful track record) to relax payment terms perhaps from net 30 to net 15. Many customers have vested interests in seeing strongly performing suppliers survive this downturn, especially since fewer qualified suppliers are likely to survive afterwards. Along these lines, it may be worthwhile to ask customers to restructure milestones, for instance, perhaps instead of one large billing milestone for the design and build of a product, breaking it into two separate milestones, with an invoice issued at completion of the design stage and another at delivery. At worst, clients may refuse, but on the other hand, an affirmative response, even one that does not fully satisfy your entire request, represents improvement over the status quo.
Spend the effort to understand the invoice approval and payment process of major customers.
For example, who needs to approve your invoice? Given that many individuals will now be working remotely, it is important to know whether invoice approvals are taking place as anticipated and if not, what alternative approval processes are available. Also, if for example your customer operates on a weekly accounts payable payment cycle, it is important to know the cutoff for inclusion in each check run and work with approvers to get your invoice included in the earliest available check run. One-day delay of an invoice approval may translate into a week (or possibly longer) delay in receiving payment.
On the liability side of the balance sheet, will key members of your management team be willing to reduce or defer salary payments? Perhaps an offsetting bonus plan focused on achieving company survival may represent a viable and motivating option for key members of management.
Major suppliers will also have a vested interest in your survival since fewer customers will likely remain after the downturn. Well-financed suppliers may be willing to extend payment terms, perhaps from net 30 to net 45 or net 60. As an alternative, it is worth inquiring about the option to stagger payments on specific invoices, perhaps 25% at 30 days, 25% at 60 days and 50% at 90 days. Again, any supplier flexibility will represent cash flow improvement.
Finally, deferred revenue (generally defined as billings in excess or in anticipation of work performed) can have a very favorable cash flow impact, representing the possibility of cash in the door without significant costs being incurred until well into the future. In the trade show industry, for example, customers are often requested and expected to make payments well in advance of actual trade show dates. Such advance payments represent deferred revenue to these trade show operators. A famous instance of deferred revenue is Tesla’s requirement of cash deposits now in advance of planned 2021 Cybertruck deliveries. Another is Virgin Galactic’s requiring cash deposits well in advance of tourists’ actual flights into space.
In the current environment, likely no single step will fully address cash flow needs of the startup or small business. However, a combination of the steps outlined here may serve to ensure the organization’s survival until the economy and external funding opportunities improve… which they truly will over time.
John Scully, PhD, teaches accounting and finance at Pepperdine Graziadio Business School, counsels senior-level executives in the Presidents and Key Executives MBA program and also teaches classes in financing the small business.