LV InsightsNavigating COVID-19

Calibrating risks at your startup at this time

The onset of COVID-19 has had a direct effect on the startup ecosystem. Not only are founders vying hard to survive the crisis but they also need to stress test their balance sheets and for that, a realistic impact on the balance sheet needs to be calibrated. 

In an interview with Syna Dehnugara of LetsVenture, Alok Mittal, serial entrepreneur and angel investor talks about the impact that the COVID-19 contagion will have on the startup ecosystem. He explains why COVID-19 is far more critical than the dot com bust of 2000-01 or the 2008-09 global financial crisis. “There is a demand-side disruption that is caused because of the healthcare emergency and the lockdowns, and there is a global supply-side disruption that is being caused because of the interruption. There is a liquidity crunch also,” says Alok. He sheds light on possible methods that startups can incorporate to calibrate risks and survive the pandemic. 

Alok Mittal is the co-founder & CEO of Indifi Technologies – a Gurgaon based company that provides access to debt financing for MSMEs. Moreover, he is a founding board member of the Indian Angel Network, an angel investor and a serial entrepreneur (having previously co-founded Monster India & Plaksha University). Alok has also worked as a VC, being the MD of Canaan Partners and his experience makes him believe that it will be extremely difficult for some startups to survive the next few quarters – revenue streams will take a direct hit and fund-raising will become more difficult. Alok says, “It is important to understand that Indian VCs have been quite active in the last 24 months. Therefore, they are tight in terms of liquidity. Valuations are going to get challenged and for this reason, VCs will face the same problems as entrepreneurs. Now, VCs would want to extend their investment runway too”. Read on. 

Syna: Alok, this is perhaps the third big disruption in terms of an economic cycle or a global meltdown that you have seen in your career as an entrepreneur and as an investor. How is COVID-19 and its repercussions different from what you had observed in the 2000 dot com meltdown and in the 2008 global financial crisis?

Alok: I think the element that is unique and complex about this crisis is that it is multi-dimensional. There is a health-care emergency, there is a demand-side disruption that is caused because of the healthcare emergency and the lockdowns and there is a global supply-side disruption that is being caused because of the interruption, initially in China and now globally. To top this there is also a liquidity crunch. All of this is happening at the same time. The dot com crash was largely a market correction where fundraising & liquidity became harder. The 2008-09 situation had some elements of the market and some elements of demand. But this COVID-19 situation is unique in its complexity where all the different elements a business relies on are simultaneously being taken down and at a higher level of uncertainty than ever before which makes any sort of planning obsolete.

S: In terms of the impact that COVID-19 will have on business, what is the way to calibrate the risk around it? It’s both a demand and supply-side disruption, and there is a healthcare crisis as well. And no one knows how long it will go on globally; even if some countries contain it, the cycle of us getting rid of COVID-19 altogether might be much longer. 

A: Historically, when there is a crisis it’s not positive for any business. Some entrepreneurs believe that this situation might be an upside for them – entrepreneurs who are into emergency services, for example. But, my experience has been that when there is a crisis, everyone gets hurt to different extents. So, entrepreneurs need to plan out their survival strategy. 

In the sequence of priorities, the first is empathy both towards customers and employees. I think this crisis is unusual as everyone is affected by it and everyone is affected in multiple ways. As much as our businesses are affected, small businesses are equally impacted by this as they are facing the same demand and supply chain disruptions, and they have the same healthcare fears. The same is the case with our employees. First, we should take that into account and think of how we can be responsive to their needs. The second is being able to calibrate what level of business we want to operate for. There are businesses that might drop by 30% and there are ones that might drop by 80%. It is important to form that view early enough and I would err on the side of caution while forming that view so that the cost structure does not pull the company down. 

The third is the burn rate and the runway you have as an entrepreneur to come out of the COVID-19 crisis and survive. In my mind, the runway for most entrepreneurs needs to be about 15 to 18 months. There are entrepreneurs that have not capitalized yet and they might have to look at cutting costs aggressively to make sure that they survive this downturn. I think it would be an error to see this as a 3-week or 6-week issue but even though the best-case scenarios that I have heard are outlining at least a 3 to 4-month active disruption, and at least a 6 to 9 month recovery period. So, I think we will see at least 12 months of continued pain in one form or the other, and that is what entrepreneurs need to prepare themselves for. 

S: How do you re-calibrate looking at a severe business downside? Many startups in India are built with the assumption that they can survive for some time in the market without any cash flow. WIll COVID-19 fundamentally change this approach people take towards cash flow in their business? 

A: Yes, these things have a cultural impact, if I may call it that. If I go back to the 2000-01 downturn, the ones that survived have a culture of profitability – Naukri, Bharatmatrimony, are companies that got built in that downturn. The present COVID-19 situation will have a longer-term impact on how founders think – how to be profitable, how to build scale, manage cash burn and all of that. The more visible impact will be in the next 6 to 9 months. There will be aggressive actions. As much as these companies are expected to empathize with their customers and employees, these companies will get hurt if they don’t let go of people. The right framework is to think of strengthening the organization.

S: 2019 was a big year for investments in India – $45 bn was invested in the startup space in India (PE & VC) and $26 bn the year before that. What would you say to a Pre-series A founder who has just raised his first funding ever vs a founder who has raised a Series B/C round?

A: The thumb rule for each entrepreneur is the same – you have to make your money last at least 15 to 18 months. The way in which people get there might be different. The good news with earlier stage founders is they have a lot of flexibility – teams are small and there is some cultural capital to manage this situation without large scale disruptions. I would actually argue that younger stage companies might be able to better manage the cost side of their equations. This becomes very hard when you go large – it becomes very hard to let go of people or enforce salary cuts or defer salaries because as you grow large, the company becomes more vulnerable and inflexible. 

Capitalization actually varies from company to company, and might not be a function of the stage at all. There will be companies with 300 people who raised capital more than 18 months back and they might have planned to raise another round of capital this year, and they may have to take more drastic action as compared to some company which might be smaller but has managed to raise funds in the last quarter. 

S: How should startups be looking at raising funds? How will VCs react right now to putting in fresh capital or helping portfolios with follow-up capital? 

A: I think VCs will go ahead with investments in startups where there is already a commitment to invest – a term-sheet or a verbal commit. In my case, I am in the middle of many commitments and I would like to fulfill my commitments. I think startup founders who are looking to hit the road for raising funds in the next few months will face more challenges. The reason might be logistical. It is impossible to have meetings at this point in time. Zoom meetings are great but unless you have chemistry, it is very hard! Today, for example, a lot of investors that I am talking to are telling me that the stock markets are down by 30% this year and we don’t know if it will worsen. As a VC fund, I should not look at the stock market, but their investors (LPs) are invested in both asset classes. So, it is much more attractive for LPs at this time to go and buy public stocks. That’s where the crunch might come from. 

S: So are global VCs with India allocations, already chalking 2020 up as a missed year and planning further out? Unlike the earlier crisis, we now have a few strong VCs that have domestic capital. 

A: I think global VCs with India allocation will make an adjustment to the allocation. There will be a little bit of ‘let’s see where this is going’. Indian VCs are sort of dry now as a lot of fundraising has happened for these VCs in the last 24 months. But, I think the reaction will be much the same. People will want to extend their runway in terms of investment periods so that they will have the capital for the deals that they really want to do. The bar is going to move up. Valuations are going to get challenged and VCs will face the same problems as entrepreneurs. For example, what happened in the 2008 crisis was that most venture firms who would otherwise invest in a 3-year investment cycle extended their investment cycle to 4 years and beyond – because their LPs were advising them to do so but also because they were uncertain if they would be able to raise their next fund themselves. As a VC, you don’t want to be out of deal flow in the market and so a better decision is to slow down the pace of decision making rather than stop altogether.  

S: From an angel investing point of view, is this a good time to actually find strong, resilient businesses and invest, or would you say that this is the time to wait and observe. And, as an investor what should one do for his own portfolio? 

A: In terms of new investments, I am not a big fan of going and jumping into a crisis. Normally one would think of stepping back and taking a pause for some months to see where things are headed. On the portfolio side, the biggest contribution that people like me can make is to talk to the companies, but not over project our experience onto those entrepreneurs. It is important to let entrepreneurs be in charge but stay available to them all the time. 

S: Your company Indifi Technologies gives out business loans to small business owners. What is your perception of the revival of the space, and how much has your business been negatively impacted? Are you rethinking the way you are doing business yourself? 

A: We are not affected by COVID-19 directly but we lend to small businesses, so all the pain our customers face will surely have an impact on our business. We are again following the same path – we understand that the customer is in pain & we need to figure out a way to help them out. In the lending businesses, there is some precedence on what kind of things can be done to make sure that the pressure on the customers is not enhanced. The disruption due to the lockdown makes it impossible to serve new customers. Everything from courier to physical verifications and even getting a signature from a customer is not possible today. So, as long as the lockdowns continue it is unlikely that any meaningful fresh activity will happen. 

One could argue that as we are in lockdown so why would the business owner need money? But at this point, the customer will need money for multiple things: one, their own receivables might be stressed. Two, the underlying businesses of our customers will continue to be impacted by both demand and supply-side issues. We are doing a sectoral analysis to understand the crisis better. The third piece for us will be liquidity – being able to extend credit to customers because we are able to borrow from the banking system and that is likely to shrink significantly. We will set certain control measures within our company to ensure that we are abiding by all the sound business practices, and also the sound compliance and regulatory guidelines around leverage, asset-liability mismatch – this will impact how much business we do. 

We have gone out and tried to speak to our investors and other entrepreneurs who had been lending to businesses during the previous crisis. In the microfinance crisis, for instance, collections for a certain period of time had dropped down to zero and that is in some sense the worst case. I think the scenario will be apparent in the next couple of weeks as we see data on actual collections materializing. We will then have a sense of the impact on asset quality. 

S: Any thoughts on different types of products and services that need to be created to actually tailor to small businesses. An idea of getting a possible reset over here? 

A: There are two directions in which innovation is getting accelerated. One is just making sure that the pace of digital processes gets enhanced. There are things on our roadmap that we would have done over a 3 to 6-month timeframe but all of that is on hold as we are trying to create a stronger digital-only passage for our customers to avail of our services. The second is product design. A lot of our customers have partnered with aggregators and large platforms. We believe by aligning with them we can help serve our customers better, be it in any sector. We are working to create more robust products especially for a situation like this where short-term liquidity will prove to be the bigger challenge, rather than a 2-3 year term loan. 

S: We have launched the LV Silver Linings Playbook – a compilation of thoughts and insights to help folks see the glass half full. What’s your silver lining? 

A: There might not be opportunities to grow the business aggressively but there will be opportunities. For example, we are taking COVID-19 as an opportunity to make sure that our product platform gets accelerated significantly beyond what we would have otherwise done. The reality is that some great companies were built through the 2000-01 and 2008-10 crises.  Entrepreneurs need to make sure that they have the survival runway but beyond that, it is important to look at how to make use of this crisis and not to let it go waste. 


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