Lessons in Crisis – What young entrepreneurs can learn now

Dr Mike Lynch discusses his experience of building a tech company through a downturn and why the key is to survive the short term and be well-positioned to take advantage of the recovery.

April 2020

The technology industry is by nature optimistic, young entrepreneurs dream of a new world better made better by new and exciting innovations that render the past obsolete. It's easy to think a downturn won't happen when you've never seen one, but that is not the reality of human existence. For millennia, farmers have known that winter always follows summer, that catastrophic diseases, extreme weather plagues, feasts and famines are all part of the natural cycle.

I was no different, and believed that the old rules didn't apply – in the new world, you either got it or you didn't. But the dot com bubble burst and the unrestrained optimism of the early 2000s gave way to a crushing reassertion of economic fundamentals.

The lesson I learnt was that the most important job in summer is to plan for winter. We designed applications that could flourish in the downturn and thus, in the 2008 financial crisis, our investment in legal services turned out to be a great bet.

Covid-19 is my third crisis, and I am no longer a CEO. Through Invoke Capital, I work with a number of portfolio companies which are too young to have lived through any bad times.

The next few weeks and months are going to be harsh and will test every entrepreneur and executive in ways that are difficult to predict.

Denial, and its half-brother, over-reaction

The initial reaction to the dotcom bust was denial and disbelief that is was more than a temporary setback. There is a danger that a degree of optimism prevails now too. What should those who didn't see winter coming do now?

In the donwnturns I had an image to encapsulate this focus – the hungry wolf. The only worry of the hungry wolf is still being here at the end of winter. It doesn't matter what a magnificent hunter they were in summer; when there is snow on the ground, the animal will eat scraps if it needs to, just to make it to spring.

Every young company now needs face up to the worst-case scenario. Build a model that assumes no one pays you for at least months, no one places a new order, and no one will fund you for 18 months. What do you do now? It's important to have a plan that assumes the very worst, then you can survive even if your more realistic assumptions don't transpire.

After the denial phase, came panic - those who are not close to the day-to-day business often demand action based on valuation and trajectory, rather than business performance. Shareholders and funders try to protect their investment, rather than the company, by demanding a rapid, drastic response. Ironically, this is often an overreaction. In the dot-com period I had a company whose enterprise value was 40p before boom, shot up to 122 pounds at the peak of the bubble, and afterwards fell to minus 10p. However, the company had hit all its projections all along. Whilst the valuation gyrated, we kept serving our customers' demands.

Many venture capitalists that have ridden the recent wave of unicorns are panicking because they have overfunded companies with little revenues and no path to profitability, holding them in their books at very high valuations that are now unsustainable. Their knee-jerk reaction is to urge their portfolio companies to avoid any need to raise money ever, which would bring about a mark-to-market, but decimate overheads and cull employees to survive on existing cash. Whilst its crucial to manage cash and spending sensibly, I would caution against cutting into the core, you'll need to service existing customers and be prepared to onboard new ones. There is funding available for good companies that might need to compromise on valuation. Listen to the board members who have lived through this before.

After panic came secrecy. When life is uncertain, there is a strong instinct to go quiet, and not say anything until you have solutions to problems. Conversely, an entrepreneur needs to step up the frequency and transparency of communication to educate and manage their shareholders. They must be seen to acknowledge the crisis and communicate their multiple plans taking into account the crisis differing possible trajectories of the crisis. Nothing is more worrying to a shareholder at a time like this than a CEO who goes dark, or tells them it won't have an impact on their business.

Pace yourself, there are different timescales to consider.

So where does this leave us? There is a danger that too many decisions are made too quickly that are later difficult to unwind, or that end up making people busy in unproductive ways that do not ultimately contribute anything meaningful. Striking the balance between pointless busy work, and decision paralysis, knowing what projects to mothball, and which ones to prioritise is one of the tests of leadership. Recall the hungry wolf, take advantage of your flexibility and pivot to your winter tasks. Never act on just one data point.

The short-term goal should be to look after customers, ensuring they continue to be happy with the product and service they receive. They will remember who they could rely on in their crisis. Darktrace, for example, is offering existing customers three months of its AI analyst product, to help detect cyber-attacks at a time when CISOs are busy trying to secure a much more distributed workforce. Ultimately, we are there to help them.

Nurturing employees is important too, as you'll need your top performers to help the company get back on its feet. Your employees will be feeling the full range of emotions of social isolation, juggling families in some cases, or cramped and crowded flat shares in others. Communicating more often than you might have when "offline", highlighting good work, and not sugar-coating the short-term pain will go a very long way to keeping morale and productivity up.

Spring will be a time of opportunity

When winter ends, those that survive will be ready to take advantage of the new landscape – competition will have cleared out, marketing costs will be low, great employees will be looking for jobs and customers will remember those who were there for them.

A business that only works in peak times has no long-term prospects, and start-ups have the advantage their larger brothers don't. They can be flexible and redeploy people to winter tasks. The surviving leaders of this crisis will have honed a durable business model and learned to build in flexibility and options that work for all seasons, and can reap the benefits of the advantages of spring.

There's a reason why the best returns in venture capital come from investments made in the winter of downturns – and an irony that most investments are made in the summer booms. For entrepreneurs, the lesson to remember is that whatever the world looks like when this crisis is over, winter will follow summer and next time, and the key is to survive the short term and be well-positioned to take advantage of the recovery when it starts.