Start-ups – Cash is King

The shockwaves emanating from the Covid-19 pandemic are being felt throughout the start-up community.  Many companies that managed to obtain funding pre-outbreak are being forced to turn their attention away from innovation and growth to focus on survival, as they navigate the challenges associated with curtailments on travel, reduced sales, supply chain disruptions and cash flow concerns.  Companies that were planning to raise capital over the next few months will be facing different challenges, as the prospect of new investment looks more uncertain.  In this update we shall examine the implications for start-ups that are nearing the end of their funding cycle, potential opportunities arising from the current situation and provide some useful advice to companies experiencing cash flow issues.

VC investment

Whilst many investors will be focused on shoring up their existing portfolios, some venture capitalists (VCs) are on the lookout for new opportunities as they seek to take advantage of reduced valuations in the hope that the market recovers quickly once the pandemic passes.  However, the sheer number of companies in urgent need of funding has given investors a wide scope to negotiate equity and drive down hard on the deal terms.  We would encourage our start-up clients in this position to consider a smaller bridging round, allowing them to raise enough funds to keep them afloat over the next few months without committing to a full equity round on unfavourable deal terms.

Another option for companies that are running out of cash is to issue new investors with convertible notes, which allow the company to receive money in the form of a loan which converts into equity at a later date.  Alternatively, start-ups could offer potential investors the opportunity to subscribe for preference shares in the company.  These entitle the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends.  This is an attractive option for VCs as they would be able to extract profit from the company before the founders once the market turns and the company begins to make profit.

The importance of adaptability

In contrast to those struggling for cash, the spread of Covid-19 has allowed certain businesses to thrive.  Some have been able to take advantage of unprecedented demand for tele-health, delivery and video conferencing services and have seen their values skyrocket as a result.  Shares in Zoom, for example, are now trading at more than 200% of their pre-Covid levels.  Others have been able to mitigate the devastating effect of the virus by adapting to offer customers a product or service that is compatible with the current social restrictions.  The stories of large manufacturers shifting production to ventilators and PPE have been well publicised, but many small businesses are adapting in a similar way – independent restaurants selling fresh produce from their storefronts, for example.  A willingness and ability to adapt will be the key factor in determining which businesses are able to weather the storm, and which are not.

Government assistance

On 20 April, the Government announced plans for a “Future Fund” to ensure that start-ups and other smaller businesses receive sufficient investment to continue operating during the pandemic. The Government has pledged to provide loans to UK-based companies by way of a convertible note ranging from £125,000 up to £5million, subject to the company obtaining at least an equal investment from a private investor.  For more information on the Future Fund, please refer to our previous update. Innovate UK, the national innovation agency, has also announced its plans to offer up to £750 million in loans and grants to businesses specialising in R&D.  These stimulus packages are a welcome lifeline for UK businesses, and are more generous than those offered by our European counterparts (the equivalent scheme in France, the French Frontier Venture Scheme, is offering up to €80 million in loans and grants).

Alleviating cash flow problems

It goes without saying that companies should be drawing up contingency plans for the next 12-18 months, preparing for various levels of distress and giving thought to the company’s prospects in the event of the worst-case scenario.

Start-ups should also be looking inwardly to see if they are able to reduce their costs – perhaps by looking at ways to increase productivity with fewer staff members. The Government has launched the furlough scheme which allows UK employers the opportunity to put their staff on a temporary leave of absence whilst remaining on the payroll, whereby the Government would pay 80% of the employee’s salary (with remaining 20% being topped up at the discretion of the employer). This scheme may be a useful instrument for start-ups who are experiencing a dramatic fall in demand and need to lessen the impact of costly employee wages in the short-term.  Companies may also want to re-think any large outgoings on stock or rental arrangements, renegotiate the terms of any existing loans with the bank, and apply for public aid.  It may also be worth contacting existing shareholders who may be willing to invest more capital at a preferential rate to new investors.

Following the Government’s announcement of the Coronavirus Bill on 23 March, commercial tenants now, in theory, enjoy greater protection over the next 3 months from landlords who would otherwise be able to evict them on the grounds of non-payment of rent.  As discussed in our update – Coronavirus: further tenant protection announced. Hole plugged? – some unscrupulous landlords have been circumventing the rules which has led to the introduction of further protection on 23 April. Landlords are now no longer able to serve winding-up petitions on tenants, or use aggressive tactics (such as serving statutory demands or written warnings) threatening the company with compulsory liquidation.  We would encourage our start-up clients to contact us if they have existing rental arrangements in place and are experiencing difficulties with their landlords.

For further information on this topic please contact Russel Shear or any other member of our Corporate & Commercial team.

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