11 May 2020
Many startups will need to adapt to survive COVID-19. We’ve identified four tips to help Australian startups endure the crisis and come out stronger on the other side.
Like the wider Australian business community, most startup companies have been heavily disrupted by COVID-19, and are currently grappling with a stream of new government policies and laws designed to help them survive the pandemic.
Every startup will be impacted differently. The most exposed startups will have businesses where revenue is severely affected by the pandemic in sectors such as leisure, travel and hospitality, particularly where they haven’t already built a cash war chest for survival. Others are more fortunate, operating in sectors which have seen an up-tick in sales from COVID-19 or having raised capital prior to the outbreak.
As an example, Australian software startup-turned-global-giant Atlassian has already adapted its strategy to come out of COVID-19 as a stronger company. Atlassian recently said that it “was born in the ashes of the dot-com bust” and that during the GFC, while many were fearful, it made decisions which “paved the way for incredible growth over the following decade”. Atlassian is adopting a similar approach now, making record staff hirings and cutting prices for core products to attract new customers, while many of its competitors cut spending and fall by the wayside.
Of course, with top-line revenue continuing to grow and more than $2 billion in cash and investments on its balance sheet, Atlassian is better placed than a startup to use this period to implement a bold and aggressive growth plan.
For startups which are now more focussed on survival than growth, we have identified four tips to help them navigate COVID-19. Businesses which follow these tips and survive COVID-19 are likely to come out stronger on the other side, while many of their competitors may fall over.
The number one rule for startups is to not run out of money.
Some venture capital firms are telling their portfolio companies to build an 18-24 month cash runway for survival. As a result, many startups have thrown their business plans out the window and are considering what levers they can pull to preserve or generate cash. This can involve reducing costs and deferring capex, shifting the company’s sole focus to its ‘star product’, or even a major pivot in the company’s strategy to adapt to new market trends.
Many founders will be speaking to investors about a capital raising. In the current climate this could lead to investor-friendly terms and ‘down rounds’, which could also potentially trigger anti-dilution clauses from prior funding rounds. However, while valuations have come off and founders need to be realistic about their expectations, private market valuations often lag behind listed markets and many venture capital firms are cashed up following pre-COVID-19 fundraisings. Raising capital for startups is likely to become more challenging once this dry powder has been used up. It will usually be easiest to tap existing shareholders, as many investors will now be more focussed on helping their existing portfolio companies rather than pursuing new opportunities.
Unfortunately for Australian startups, recent changes to Australia’s foreign investment regime have made it more difficult to secure cornerstone foreign shareholders. Specifically, any foreign investment resulting in a shareholding of 20% or more in an Australian company will now generally be subject to the FIRB regime (with lower thresholds applying to foreign government investors) and, as discussed in our recent article, FIRB has indicated that it may take up to six months to review new applications.
Startups can also consider other sources of cash generation, such as grants, R&D concessions and the JobKeeper Program. They can also speak with their financiers and landlords about deferring payments, as we’ve discussed here.
The health and safety of employees and contractors should be paramount for all companies during the COVID-19 pandemic, particularly where staff continue to attend the workplace and may be exposed to the virus. Startups should consider implementing policies to safeguard their team and must ensure that they comply with relevant health and safety laws and the latest government COVID-19 guidelines.
Payroll is often one of the largest costs for a business, so startups need to undertake a critical assessment of the intersection between their cash runway, their staff numbers and their top talent. This assessment should factor in the availability of government incentives, such as the JobKeeper Program (which we have discussed in detail here), and whether there may be creative solutions to keep employees on the books while still minimising cash burn – for example, reducing working hours, freezing salaries, imposing voluntary unpaid leave, and compensating staff through equity plans.
Indeed, many startups have a competitive advantage over bigger companies in this area. Startups typically have a smaller and more agile employee base which is used to flexible and remote working, with many also providing lower cash salaries in return for granting equity under employee share plans.
Startups can use this period to critically assess their team members. With cash tight, it might be time to let go of underperforming workers, but startups need to look after top talent who might otherwise be lured to a cashed-up competitor. Founders can help to mitigate this risk by demonstrating leadership, including cutting their own pay and engaging with staff in a sensitive and transparent way.
The importance of leadership and communication during COVID-19 applies to all of the company’s stakeholders, including customers, suppliers, staff and shareholders. This includes explaining the steps you are taking to address COVID-19 issues, as well as taking the time to understand the perspectives of each of your key stakeholders and the impact that COVID-19 is having on them.
Many startups are relatively new and haven’t yet built longstanding relationships with their stakeholders. As a result, it may be harder for startups to rely on stakeholder loyalty and trust in the current climate, and founders may be more acutely judged on how they respond to the challenges of COVID-19. Startups which communicate proactively and demonstrate strong leadership are likely to instil confidence and build loyalty and trust with their stakeholders for years to come.
As part of managing relationships during COVID-19, startups should also review their existing contractual arrangements with key stakeholders to understand their rights and obligations, and potentially consider alternative supply arrangements. Particular attention should be given to contractual provisions about payment terms, termination rights and force majeure provisions, all of which may be tested as a result of the COVID-19 pandemic.
Directors are likely to be making a range of business-critical decisions as a result of COVID-19, including on the issues discussed above.
In making these decisions, directors need to be aware of their duties under the Corporations Act 2001 (Cth). These include duties to act in good faith in the best interests of the company and for a proper purpose and to act with reasonable care and diligence. In discharging these duties, directors need to assess the foreseeable risk of harm to a company, including non-financial risks such as reputational harm and compliance with laws. Directors can also be personally liable where the company itself breaches certain laws.
Some laws, such as insolvent trading laws, have been temporarily relaxed due to COVID-19. Specifically, while directors can normally be personally liable for debts incurred by the company when it was insolvent, these rules won’t apply to debts incurred by companies in the ordinary course of business during the pandemic.
However, most laws continue to apply notwithstanding the difficult business environment, and poor decisions made now could subsequently result in a lawsuit from aggrieved stakeholders. For example, raising capital at all costs and on unfavourable terms may seem an attractive way to build a cash runway in the short-term, but may not ultimately be in the best interests of the company and its existing shareholder base.
Similarly, in light of the widely reported increase in privacy and cyber-security breaches during COVID-19, the directors of startups companies should consider ways to mitigate the potential legal and reputational risks in these areas.
We discuss in more detail the importance of businesses not ‘cutting corners’ during COVID-19 here.
This article is part of our insight series COVID-19: Navigating the implications for business in Australia and beyond. To get notified by email when new COVID-19 insights are released, please subscribe for updates here.
The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.