Home Venture Capital Prepare Your Business for The Great Rotation

Prepare Your Business for The Great Rotation

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The volatility of the financial markets feels far away from most small business owners, but fractional CFOs like me are increasingly concerned about the impact of capital markets on our clients. Do you know how your business may be vulnerable to what’s happening on Wall Street? Here’s a summary of how today’s financial markets may impact your business strategy.

The growth of risky investing.

Starting in the crisis of 2008, The Federal Reserve adjusted its policies so that treasury bills (considered the safest investment in the world) yielded 0% returns, meaning they paid no profit. With this safe-haven investment gone, investors must put their money elsewhere to get returns. 

The result was a 14-year-long boom for risky investing at every level: tech company stocks soared, private equity expanded into new markets, venture capital exploded in popularity, and DIY investors (often newly rich from employee stock options) dove into angel investing. Many advancements in the past ten years – from electric cars to AI to life-saving medical discoveries – were funded by this tech-investing boom. 

The great rotation.

On March 16th, 2022, the Fed abruptly changed its policy to tame inflation. While widely viewed as an appropriate overall adjustment, one necessary consequence is the re-creation of risk-free assets: treasury bills now yield 0.65%, a 13x boost versus just three months ago. Markets have responded in what some call “The Great Rotation” – a shift in portfolio allocation from risky investments like tech into value stocks, bonds, and cash.

The Great Rotation directly impacted the public tech companies like Instacart, which lost almost 40% of their value at IPO. In addition to the evident public market changes, invisible changes are happening to smaller capital markets.

  • Venture capital funds are having trouble raising new funds as investors are now “over-exposed” to risky investments.
  • Private equity, which relies heavily on lending, is putting companies through more scrutiny as interest rates raise their cost of capital. 
  • Businesses are delaying strategic acquisitions as they reserve cash for inflation and supply chain challenges.
  • Angel investors, whose portfolios have shrunk with the markets, are pulling back on investment volume.

In aggregate, there is less cash for risky startup businesses at every funding stage.

Strategies for small businesses in the great rotation.

Your business’ vulnerability to The Great Rotation depends on your operating cash flows. Cash flow positive companies do not rely on outside capital, making them well-positioned for current market volatility. Venture-backed startups in a raise/burn cycle are the most susceptible, depending on how much runway they have. For now, as a rule of thumb, you should expect your next VC round to take twice as long as initially planned.

Here are a few strategies to reduce your capital market risk.

Become cash flow positive.

The best way to protect your business from capital markets is to remove your need for outside capital by becoming a profitable and cash-flow positive business. Depending on your company structure, that may mean slowing down or stopping growth, deferring long-term investments, or restructuring your organization. These actions hurt your long-term growth, so contemplate each change carefully.

For some startups, cash flow positive is all but an impossibility (e.g., early-stage pharmaceuticals.) If so, consider other options below.

Refinance debts now.

Although not yet gone, the window is quickly closing on low-interest loans. Now is still an excellent time to refinance business debt like MCA loans or AR factoring to improve cash flow and reduce interest expense. Talk to your bank or CDFI to see if refinancing is a good option. 

Accelerate the close of your venture round.

If you are actively raising a venture round, consider accelerating the close. You may need to drop your valuation, concede to demands like board seats or warrants, or reduce the size of your raise. Despite these drawbacks, it may be better to finish any round now versus not being able to close in the future. 

Extend your runway.

If you are currently burning runway, consider steps to buy yourself more time. Extending runway usually means reducing expenses or headcount – a painful step backward for high-growth companies. Reducing burn is a gamble to buy more time at the expense of traction. Yet investors also want to see traction before your next round, so contemplate this strategy carefully before deploying it. Work closely with your business forecast to understand how a drop spending may impact traction.  

Seek public funding.

Government grants remain well insulated from capital market trends, so consider applying for an advanced industries grant through the National Science Foundation, the Department of Defense, or other well-funded government agencies.

Plan early and often to leave yourself options.

No matter what happens with the capital markets, it never hurts to plan for the worst and adapt as needed. Work closely with your managers and advisors to pick the best strategy for your business and avoid catastrophe from causes outside your control.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.

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