After a decade of expansion is the next downturn looming? Here’s some good advice for start-up and growth stage CEOs to be prepared for economic contraction
The economy has been expanding for almost a decade now, one of the longest periods of economic expansion ever. While some indicators like record low unemployment and still-strong consumer and business optimism point to ongoing strength, other signs point to a possible cooling off, such as reduced GDP estimates, volatility in the public markets and falling longer-term bond yields.
While turning points in cycles are hard to predict without the benefit of hindsight, eventually there will always be a downturn. Nonetheless, a weaker economy doesn’t have to be debilitating or a time of fear for companies.
For executives at growth-stage companies in particular, planning appropriately and taking early action before the economy worsens can be the difference between not just surviving a downturn, but thriving in spite of one. Done right, a company can exit this period with improved operations, a stronger competitive position, and, quite possibly, a better balance sheet.
What happens in the next downturn will be particularly interesting because so many companies founded during the current economic expansion have not yet had to weather a downturn. With the impact on these businesses unknown, the need to scenario plan and stress test is quite acute.
Know Your Exposure
One measure proactive boards and executives can take is to identify areas of vulnerability and whether those areas can be de-emphasized or possibly off-loaded before it’s necessary.
Ideally, there are levers that can be pulled to diversify revenue or accelerate profitability if and when a downturn hits. For example, we can look backward and see the looming danger in 2007 for companies overexposed to the mortgage industry or in 2000 to those overexposed to the tech sector. Reducing exposure to those segments or diversifying into other segments could have helped avoid trouble later on.
Extend The Runway
Another mitigating step is to reduce future financing risk. Companies don’t want to be in a position of needing to raise capital during an extended downturn. This can be avoided by pre-emptively reducing the cash burn rate, increasing free cash flow (or becoming cash generative), or by raising new funds when times are still good.
With the current robust funding environment, it’s possible to raise new funds every 18 to 24 months, but that becomes more difficult in a softer economy. The strongest companies will always be able to get more funding, but higher valuations can be harder to come by, terms can become more onerous, and the size of a potential investment round can be limited.
Try to Stick To The Long-Term Plan
I encourage executives not to lose focus of their long-term goals. In good times and bad, leaders shouldn’t let external forces unnecessarily influence their path. This is a tough one to stick to when conditions deteriorate but staying focused on long-term goals can help executives or a board with a frame of reference by which to measure short-term decisions.
This is not confined to economic downturns: Discipline should never go out of style. Whether with costs, forecasting, or hiring, establishing a culture of discipline for all conditions is helpful, smart, and prudent. With an established culture of discipline, executives will be in a better position for any shock to the business.
Overall, big companies and small companies all have to weather rough conditions at some point or another – the difference between failure and success often comes down to who is best prepared.
Dave Welsh is a Member and Head of TMT Growth Equity within KKR’s Private Equity platform, where he serves on the TMT growth equity investment committee.
The views expressed in this article are the personal views of Dave Welsh of KKR and do not necessarily reflect the views of KKR or the strategies and products that KKR offers or invests.