Leading Your Private Company Into 2023
Steven J. Keeler
Business Attorney for M&A, Capital Raising, Growth and Exit Strategy and Execution
Part I: Financial and Management Planning for a Downturn
Our posts and planning articles have recently focused a lot on company capital raising and sales. But you have a business to run, and once again, your management is being tested by economic uncertainty. And you know that surviving (or even thriving) through any “downturn” is not only about your company’s internal housekeeping, but also about the players in your end markets, customers and suppliers.
All market “corrections” produce winners and losers, and planning through adversity means you need to update your “SWOT” analysis – an assessment of your company’s strengths, weakness, threats and opportunities. And with no crystal ball, your SWOT analysis will need to continue in real time. At the operational level, the right balancing act – for example, as between survival to mitigate weaknesses and threats, and pivoting to capitalize on strengths and opportunities – will be different for every business.
Your C-suite is probably waiting on some indication of how bad things might get, and your decisions and action plan will depend not only on your company’s industry, life cycle stage, capital structure and needs, and your owners’ personal goals and plans, but also on the impact of a downturn on your suppliers, vendors and customers.
We’ve often said that every company should be operated as if it were for sale, as making your company attractive to investors or buyers can add immediate value to the owners’ equity. Business and economic downturns often produce new business models and even opportunities for some businesses to thrive. All downturns eventually end, and staying the course in your business planning will put your company in a better position when things improve.
This post is Part I of two posts which share what we see companies doing to plan for tough times and better times. This one focuses on more immediate company finance and management blocking and tackling. Part II will remind us not to ignore strategic and growth planning.
What’s Your Company’s Industry and Life-Cycle Stage?
Emerging Growth Tech Companies
It’s as fascinating as frustrating that early-stage technology companies always seem to feel the pinch of most recessions, primarily due to lower valuations and a pull-back in venture capital and minority growth investing. The Wall Street Journal is describing this downturn in part as a “white-collar recession” characterized by tech company layoffs and a NASDAQ market decline.1 This environment will encourage venture capital-backed companies to consider debt versus dilutive equity capital, despite the risk of rising interest rates. As in previous downturns, emerging growth and “startup” companies will be hit from two sides – a more challenging capital raising environment coupled with reduced spending on tech company products and solutions. But as with the pandemic, this downturn will bring technology innovation, allowing some companies in verticals such as cybersecurity, supply chain solutions and drug discovery to grow provided they can manage their bottom lines through the storm. Their balancing act will involve growth coupled with profitability and cash management. So far, staff reductions have been a popular first move for many tech companies. As for business growth, which is more critical to earlier-stage companies, pivots to new products and solutions that address business and consumer needs as well as government spending may have to be the planning focus. As with prior “boom-and-bust” business cycles, lower costs and managing cash will be the near-term challenge for emerging growth and tech companies.
Lower Middle-Market Companies
In contrast, if yours is a lower middle-market company in a sector like manufacturing or distribution, you may have years of profitability under your belt, but similar to tech companies, the consumer or business markets you serve may be hurt by the economy. Retailers will be challenged by the inflationary need to raise prices with the threat that consumer spending will eventually stall. You may benefit from the opportunity to hire new talent following layoffs and renegotiate more favorable vendor contracts, but customer spending may decline in the near term. Companies with existing debt or near-term borrowing needs will have to confront higher financing costs. More mature companies that provide a cloud computing, cybersecurity or automation solution within their product or service mix, or who can adjust their products and solutions to subsectors in comparable high demand, may actually benefit from increased business spending in these areas. The same goes for companies that address supply chain, logistics and transportation, and even ESG, challenges for their customers. Unfortunately for many in the workforce, technology solutions can often allow businesses to cut staff. Suppliers and vendors may be as critical to your business as customers, so in addition to staffing cuts and steps to improve efficiencies, many companies may choose to allocate their own spending to a larger group of vendors and suppliers who may be experiencing their own troubles during a downturn.2
What’s Your Company’s Capital Structure and Succession Plan?
Some companies were already considering capital raises or sale transactions prior to the onset of the current downturn. Some will have to stay that course despite lower valuations, while others will have the capital to continue until better times return. Companies with near-term capital expenditure needs or plans will have to confront capital and debt market struggles. Those whose profits are sufficient for sustained operations and even growth will fare better. In planning for a recession, some challenges like inflation, supply chain and raw material prices will not be as easily controlled, making staffing, real estate, advertising and G&A costs the most likely candidates for budget cuts. The Wall Street Journal is also encouraging companies to employ some “zero-based budgeting” - looking at every income statement line item rather than simply adjusting last year’s numbers based on hard-to-determine projections. This accounting discipline will enable many companies to make positive permanent changes in their cost structures.3 The private equity and merger and acquisition markets for lower middle-market companies still appear more resilient than in the larger company market. So 2023 may bring a continued opportunity to position your company and create a “recession-resilience story” if you choose to raise capital or exit. Your story should address not only customer demand but also the company’s debt position, profitability and future capital needs. Cash and inventory management have never been more important nor challenging.
Business Planning Through and For Life After the Downturn
Business planning in a recession (whether actual or coming) requires a balancing act. On the one extreme, some startups and lower middle-market companies (depending on their industry, stage, capital structure and succession planning options) will be compelled to raise dilutive capital, sell the business or restructure their debt and equity capital. On the other extreme, companies with some time and capital runway will have more options, but they should continue managing costs and expenses while seeking ways to enhance growth. Many companies in the middle of these too extremes may be able to raise capital or do a merger and acquisition transaction on relatively good terms.
Whether staying the course and waiting out a recession, or moving forward with a financing or sale transaction, planning for the recession will not only ensure survival but may allow certain companies to reengineer their operating and business models and capitalize on the variety of challenges in the current economy. Everything is the same this time, but everything is also different, and each company will have to tailor the right plan to its unique challenges and opportunities. As a result, while market valuations for businesses may fall, some companies will find a way to preserve or even increase their value through careful finance and management planning.
Stay tuned for Part II of this post, in which we will stress the importance of not using the downturn as an excuse to neglect critical mid-to-long-term strategic and growth planning.
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1 https://www.wsj.com/articles/survival-lessons-from-past-tech-downturns-11670627117.