Your clients are probably looking to you as a CPA if you work with startups because you can help them be ready for the worst.
Let’s face it: the economy isn’t likely to return to normal anytime soon. The pandemic, a war in Ukraine, disruptions in supply chains, and rising inflation (which the Fed has been trying to address by raising interest rates) are all conspiring to slow economic growth. While the labor market seems to be currently strong, the Bureau of Economic Analysis (BEA) reported that real GDP fell by 1.6 percent in the first quarter of 2022. A recession is not a foregone conclusion, but the danger signs are there.
If you work as a CPA for startups, your clients are possibly looking toward you to help them plan for the worst. While these are trying times, they also provide a chance for CPAs to step up and serve as de-facto advisors, guiding clients through unfamiliar territory. A CPA can be a hero and form lifelong bonds with clients if properly executed. If you have clients who have never been through an economic downturn, you may need to teach them what to do and, more importantly, what not to do. Let us begin with what must be done.
1) Find ways to make the runway longer.
A runway is the quantity of time a startup can operate without losing money. Startups with longer runways, such as two years, do not need to be as extremely worried as those with only six months of funding. However, every venture can benefit from cost-cutting measures, so it is recommended to:
- Conduct an audit – Every company should perform a line-by-line evaluation of expenses to identify areas where costs can be reduced. Whereas most travel and expense items seem to be obvious targets, the majority of business spending is heavily reliant on three factors: payroll, rent, and contractors. Subscriptions as well as marginal costs are insignificant and will have no effect on your budget, so concentrate on the big expenses.
- Get the CEO ready to address the team. Before making any cuts as part of the audit, management should consult with the staff. You should start encouraging your clients to be open about the company’s financial situation and solicit their feedback on cost-cutting measures. Founders and CEOs frequently discover that what they thought were essentials were not.
- Hiring should be slowed or halted. Payroll is typically the most expensive aspect of a startup. Consider delaying new hires till the startup is in a better financial situation. Reducing staff numbers should be a last resort; startups are typically lean, and cutting employees may result in missed milestones. Benefit cuts, salary cuts, and dismissals are all options, but they will all have a negative effect on productivity, team spirit, and reputation.
- Look for cash yield. One major benefit of the Fed increasing interest rates would be that startups with a lot of money in their bank accounts may now be able to earn a return. Additionally, that extra money may be necessary to maintain a key hire. CPAs ought to be connected to banks and other organizations that can aid a startup in managing its cash. Additionally, accountants can assist founders in comprehending the amount of liquid capital they require as well as the value of cash preservation when performing yield-focused cash management.
2) Assist in raising capital.
Raising capital may be an opportunity if your startup is getting momentum and you have a solid financial framework and strong metrics to demonstrate to investors or lenders. However, things have shifted since the valuations of 2020 and 2021, and professionals will almost certainly be needed to assist founders in adjusting to the current conditions:
- The importance of due diligence is greater than ever. Founders must be able to present their plans and offer evidence of a long-term strategy since VC investors want to know how their money will be used wisely. Furthermore, investors are doing more research, checking references, and performing evaluations, which results in a delay in venture capital funding transactions. In these cases, startup clients will require more detailed information and longer projections.
- Deals could be more structured. Term sheets with investor protection provisions are becoming more common. When the capital was readily available, VC investors could not impose protective covenants. Now, venture capitalists include preferential treatment terms and clauses, such as multiple liquidations, in which investors receive double or triple their capital back before other shareholders are paid. Another potential liquidation clause could be that the VC investors get their money back plus a share of any money that is left over. CPAs may need to inform their startup clients about these downside protection clauses since they haven’t been used frequently in recent years.
- Lower valuations are the norm. To obtain funding, startups may simply be forced to accept a lower valuation. CPAs may be required to assist startup clients in accepting lower valuations and restructuring their pitches in order to reflect the new environment.
3) Cut out the emotion
Every employee in a startup feels the strain when funds is limited. Moreover, stress can influence our judgment. Startup founders require a logical, data-based strategy to navigate economic hardship and advance toward recovery, and accountants supply the information. It is advised to:
- Don’t tell, show. CPAs are crucial to collecting the data that will be used by company leaders to show the long-term road to success and growth. To reassure shareholders, the board of directors, and staff members that there is a plan, communication is vital. Instilling trust is critical, especially for staff members. It will be difficult to find replacements for experienced technicians, developers, and researchers if they become demotivated and quit.
- Seek out opportunities. Concentrate on and identify the initiatives required to grow the startup, as well as set priorities for resources and funding for those investments. Competitors can be eliminated by tough markets, and startups are no exception. Top talent may be available for hire as a result of layoffs at other businesses. Similar to this, when a startup lacks the necessary capabilities to sustain itself, that may open up venture capital for startups with more potential. CPAs can assist startup clients in making a more compelling case.
- Don’t give personal guarantees on business loans. When the economy falters, business owners may look into loans requiring a personal guarantee, which would hold them liable for any outstanding debt if the company went out of business. These guarantees are frequently required for small business loans. Generally speaking, entrepreneurs who have secured outside funding should refrain from pledging their personal assets as collateral for a loan. Startup accountants must carefully discuss any possible risks with their clients in those rare circumstances where taking a chance may be worthwhile.
- Don’t be afraid of losing a round. The high valuations that startups have received in the past are frequently given too much weight. On the other hand, there are times when a down round is justified because it allows the startup to reset in a manner that reflects the realities of the current economic situation. However, trying to support an unjustifiably high valuation can lead a startup to make serious mistakes, such as raising burn rates to unsustainable levels. Owning a smaller piece of a larger pie might very well make sense. A CPA may be required to walk a founder through all the math to demonstrate the potential benefits of having to accept a down round.
4) Encourage openness.
In a difficult economy, it is crucial to communicate with all stakeholders very clearly. The board of directors, the company’s customers (if any), the employees, and the founders must all be regularly communicated with by the founders. All of these organizations want your business to succeed, and they can all make suggestions, encouragement, networking opportunities, and even funding. Founders should keep everyone up to date on current plans, key decisions, and overall strategy, and a startup CPA can provide feedback on these updates.
Take the necessary steps
It is too early to predict where the economy will go. The current downturn could be a short-term blip or a longer-term correction. Every startup, however, can profit from taking measures to improve efficiency, get funding, and refrain from overreacting. CPAs can support founders in taking the appropriate actions to cope with the recession and the current economic climate. Additionally, startups that adjust to the shifting market conditions may come out stronger after a downturn.
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