At the publishing of this piece, many business leaders are sitting down to discuss whether their businesses can withstand a potential recession. When financial media outlets are using phrases like “economic downturn” or “recession preparation,” how should growth-oriented, privately held businesses be preparing in times like these? How can they better position themselves to look at a downturn through the lens of opportunity rather than uncertainty? The lessons outlined below mirror how we’ve approached preparing Archetype and how we are consistently checking in with our business plans to ensure we can weather any storm.
In this piece, Stephen Kaye, one of our senior advisors, lays out best practices for preparing for an economic downturn. This is a distillation of thoughts that Stephen discussed with our CEO, Chetan Bagga, over a series of meetings in the latter half of 2019. Stephen has filtered these ideas through his experience weathering the last recession.
What Recession Can Mean for Growth-Oriented, Privately Held Businesses – and What They Can Do to Minimize Adverse Impact. Or, How to Grow Asparagus
By Stephen Kaye
12 minute read
It is now more than ten years since the great financial crisis and the recession that followed. At some point there will be another recession. We can all speculate on when it will happen and how deep it will be, but it will happen. When it does, there will be less notice than we expect, and it will seem obvious in hindsight. Many of the generation now leading growth-oriented, privately held businesses have never known a recession. These leaders must be thinking through now what a recession may mean for their businesses and what actions they can take to protect them from the worst effects of a downturn.
My experience in 2008 and 2009 left me with some regret in the sense that there was so much that could have been done earlier to avoid some of the actions that we were ultimately required to take. In hindsight, I should have taken actions as we approached what we all recognized as the “closing innings of the game.” Doing so would have been much easier, and certainly much less damaging to the business.
Lessons I Learned from Weathering a Recession
- Learn Lessons Past – While each downturn will present some new and unique challenges, there is wisdom available that can help navigate.
- Secure Access To Capital – Act to ensure funds exist that will allow you to deal with a range of adverse eventualities.
- Review Cost Structures – Inspect them before being forced to, and do so aggressively.
- Check In on People Performance – Having tolerance of low performance helps no one.
- Over-Communicate Your Actions – Transparency is always a good disinfectant.
- Dig a Ditch – And, don’t wait.
Learn Lessons Past – The Past Can Help Predict and Prepare for the Future
“History doesn’t repeat itself, but it often rhymes.” – Mark Twain
Whether this attribution is true or not, there is much value that you can gain as a business leader from reflecting on history.
With the great financial crisis of 2008 well in the rear-view mirror – at least in business terms – many at the top of organizations today have never led during a recession and don’t have direct experience with what this can mean for their businesses. Lessons that were learned the hard way by those of us who were around and leading businesses in 2008 are worth consideration, no matter what the next downturn looks like.
The 2008 crisis saw access to capital that organizations needed – and had anticipated – drying up rapidly with transactions put on ice, and bank credit lines reduced and even removed. It saw sales canceled – even when the business case was compelling – and payment cycles extended as many businesses were managed for liquidity and solvency, rather than profitability or value creation. The need for survival trumped all others.
Privately held, growth-oriented companies faced specific challenges in those difficult times. Some didn’t make it and many others were never the same. Use your network to tap into the wisdom of those who’ve led in a recession and learn from their experiences and mistakes – you’ll be glad of it when you have to deal with the same.
Secure Access to Capital – Distinct Capital Needs of Growth-Oriented Businesses and How to Sustain Them
“Nobody ever regrets making fast and decisive adjustments to changing circumstances.” – Sequoia
Growth-oriented businesses have distinct needs – be it expanding into new markets, growing their sales force, opening a new location, or any other of the many issues to manage as they scale. Often there aren’t the “hard assets” to support bank financing, and the capital deployed in the business comes from a combination of operations, founders, and rounds of investment raised only as required to execute shorter-term plans. They need to raise smart.
When obtaining additional capital involves dilution and a real or even perceived loss of control, the price of that capital is more than a mere financial decision. In these cases, the capital that the business desperately needs is often seen as too “expensive” to owners. Consequently, these businesses operate and grow “on a shoestring” with excess capital at a premium and buffers thin.
When times are good and an economic downturn is nowhere to be seen on the horizon, there is a reasonable expectation that capital can be obtained on an “as-needed basis.” This may seem optimal – minimizing dilution and loss of control. However, it introduces additional risk in the event of a downturn. An example of such risk is highlighted in an article in June 2019’s Harvard Business Review “How to Survive a Recession and Thrive Afterward.” It tells how “in early 2000, a five-year-old online bookseller called Amazon.com sold $672 million in convertible bonds to shore up its financial position. One month later, the dot-com bubble burst and half of all digital start-ups went out of business over the next few years, including lots of Amazon’s then rivals in e-commerce. Had the bubble burst just a few weeks earlier, one of the most successful companies ever might have fallen victims to that recession.”
As a business leader you must repeatedly stress test your cash and capital needs and consider the “cost” of not having adequate capital. Test it, not only in the sense of “might the business fail,” but also in terms of what kind of onerous terms and rates a provider of capital might require or be able to extract when times are tough – and they will!
The old adage, “the best time to buy an umbrella is when it isn’t raining,” comes to mind. Don’t be penny wise and pound foolish. Secure access to capital that will allow you to deal with a range of eventualities, including, the loss of a key customer, adverse changes in payment terms, and the cost of restructuring operations – all of which would be cash negative. Carefully review any covenants under a stress test scenario. When times are tough, capital providers will certainly be looking carefully – so check them now.
Review Cost Structures – Aggressively, Before It’s Too Late
“Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1” – Warren Buffet
Growth-oriented, privately held companies, where capital is at a premium, don’t want to get locked into a cycle where funds are diverted from growth initiatives to pay for short-term impact of cost reductions. This can create a downward-spiral – from which recovery is difficult.
While larger companies with excess capital can bundle all of these costs into a one-off restructuring charge and minimize the impact on growth areas, those operating on shoestring capital are often forced to “rob Peter to pay Paul.” The longer-term impact of such decisions can be disastrous – missing out on a product launch cycle, for example, may permanently impact growth prospects.
Consequently, it is critical you keep costs low and variable and are laser-focused on your strategic growth agenda. Even the best managed companies allow a little flab to develop when times are good. Before it rains, take a good look at all elements of your cost structure and critically review any additions to your fixed cost base. Don’t add to it without thinking about whether – or perhaps even better how – resources can be redeployed from less strategic areas of the business.
It is critically important how you manage this cost rationalization initiative. Be very careful how you delegate responsibility. While you generally want to empower managers who are closer to activities with securing cost reductions, my experience is that they often look for the low-hanging fruit, and that’s not always the right answer. Your approach should be rigorous and strategically focused, and this requires objectivity. So, consider assembling a high-level team to provide oversight and review what actions are proposed and how they are acted upon. Shared commitment and learning can be a powerful driver.
Research done by Boston Consulting Group indicated that companies who have a tentative response to early signs of a downturn, like minor budget reductions, tend to overreact later on. “Companies’ reactions to downturns have often been defensive, delayed, and insufficient.” These insufficient actions taken early on cause most businesses to create even bigger holes that they must then find a way out of when the market bounces back. Developing a war chest and a team to serve as a measure of oversight should not be done as a last-ditch effort, but rather one of good business practice. You should feel confident your business has “the liquidity necessary to weather the crisis.” If you don’t, you should go back to the drawing board before you must break out the shovel. Once you’ve prepared your business for the downturn, then you can start to think about how your business can benefit from it.
Check In on People Performance – It’s Best for All
“If you hire people just because they can do a job, they’ll work for your money. But if you hire people who believe what you believe, they’ll work for you with blood, sweat, and tears.” – Simon Sinek
Now is also the time to ensure that you are actively and rigorously managing the performance of your staff. Low performers are often recognized more broadly within the business than management suspects. It is impossible to create the kind of high-performance culture any organization aspires to if sustained low performance is being tolerated. Employees generally understand the need for performance and the need to take action with regard to low performers. Done objectively and appropriately, this can energize high-performing employees and create direct opportunities for some of your brightest talents.
It is also my personal experience that you don’t do your employees any favor by making reductions at the height of a downturn. It may be a lot easier for them if changes are made when the economy is still strong than leaving them scrambling when the economy is down. That said, how you deal with people leaving your firm is a big driver of your organizational culture so doing this in a consistent way is essential. To avoid negatively impacting the morale of your organization, it is important to be “fair” with people and transparent in your communications.
Over-Communicate Your Actions – Always
“The single biggest problem in communication is the illusion that it has taken place.” – George Bernard Shaw
Whether acting in a downturn or a lush period, it is critical to over-communicate. Once again, a common refrain is appropriate – “Communicate, communicate, communicate.” The importance of communicating to staff and other stakeholders about your actions is critical, and there is an easy message – “These are initiatives to drive the longer-term success of the business.”
If you fall foul of what George Kennedy’s character in Cool Hand Luke called a “failure to communicate,” you create business risks. For example, poorly communicating to employees about staff reductions could have a devastating impact on how the best performers – often those most critical to the future success of the business – react to the news. This turns an opportunity for personal development and advancement into a cause for fear and questioning of the future.
Authentic leadership requires transparency and engagement. So, engage staff in the process, tell them what is being done and why, and seek their input and recommendations for areas of cost reduction and refocus. Give the initiative a name, stress why doing this is important for longer-term success, keep them informed with regards to progress, and even provide rewards for individual and shared success in these areas.
Dig a Ditch – You Should Be Growing Asparagus
Faced a decade ago with deciding upon and taking serious actions at the height of the downturn, I was reminded of the question – “How do you grow asparagus?” This was answered by “Dig a ditch three years ago!”
None of this is rocket science. These items are not individually difficult, but they require focus and a commitment to identified areas of strategic importance as well as a commitment to ongoing operational excellence. This may seem like housekeeping, but it is critically important, and in essence, it is management.
Mitigating the effects of a recession requires you to have:
- A capital structure that is fit for purpose under highly-stressed conditions
- Cost structures carefully reviewed on an ongoing basis to ensure that these are not only lean but also focused on your strategic initiatives
- Employee performance closely managed to drive a performance culture
- Open and transparent communication with your workforce
Taking these actions in advance will ensure that your business will come through any recession with minimal adverse impact and is able to take advantage of future market opportunities presented. Dig that ditch now to prepare for the best crop in the future!
About the author:
Stephen Kaye, is a senior advisor to Archetype Solutions Group, was Chief Financial Officer of Hay Group, a global leader in people strategy and organizational performance, from 1998 to 2013, and its Chief Executive Officer from 2013 to 2015 until its sale to Korn Ferry International, the global people and organizational advisory firm, in 2015. Subsequently, he led the combined consulting business of Korn Ferry and Hay Group until 2017.