Turning around the failing start-up- A challenge
Many SMEs in India are undergoing severe stress due to disruptive policy actions by the Govt and start-ups are no exception. It requires smarter strategy to ride out the challenge.
Recently I had an interesting interaction with an entrepreneur who has passionately set up his business in the hospitality sector. The business was designed to be up-market and strategically located. The interiors were designed to appeal to higher taste. The place is very spacious and relaxing. The staff was well trained and moulded to assist high-end clients expected in such a place.
The entrepreneur has devoted a lot of time to create a unique place to entertain guests. It took a considerable amount of time in bringing the business up. They have invested all their savings. They raised bank loan by pledging their own house. The loan amount is quite high in relation to the value of their property and there is no room further for raising a loan against their property.
They have started the business in grand style and slowly the business was picking up as planned, however, the profitability remains a far cry. In the meantime, Govt stated bringing too many regulatory actions that have affected the fledgling business very badly.
The first Govt brought in demonetisation of large value currencies that has taken away the scope for discretionary spending for a large section of targeted customers of the business. The blow was very severe and it was a hard struggle to cope with pressure on cash flow. Thereafter Govt brought in GST that caused severe disruptions in the flow of business. In the meantime, Supreme Court banned liquor vending on highways. It is another major source of revenue for the business they are in.
These policy actions have unanticipated disruptions to the business. Add to this, suddenly urban local body has initiated certain infrastructure development in the vicinity of the business; thus effectively choked the access to the business place for customers.
Flabbergasted founders started looking for a fresh loan facility to keep the business going despite the fact that the business slipped down to 20% peak sales and the operating income barely enough to service the debt even in the peak level of turnover.
Debt funding in the distressed situation- is the right choice?
They were looking to raise additional debt fund when the going is uncertain. There is no clear roadmap for a turnaround. They have only one thing before them that is HOPE. They are hoping that good time will revisit in the near future and they will be able to turnaround.
Hoping for a good time is not a turnaround strategy at all. That only makes people delay taking hard decision and accumulate the pains.
Secondly, as we said in our previous blog, the debt has poor risk absorption capacity. It cannot be relied on in difficult time. Please read :
Please read: Embracing Private Equity – A need for SMEs in India
In the instant case, raising debt means only postponing the actions of looking closely into the business viability and drawing a robust strategy.
The best course forward-Taking it as challenge onto oneself
The business is in distress. The factors (responsible for) not within the control but the impact is expected to remain to linger for some more time and hence it requires that business makes a bid to turnaround itself and we found following are the key strategies to stay on course :
- Cost cutting exercise
- Increase the sales through diversification
- Infusing fresh equity than increasing debt
a) Cost Cutting exercise: In the instant case, the promoters have glossed over the immediate tasks of rationalising the costs rather they have assumed that present level of staffing and luxuries are needed to meet the demand from the market as and when picks up. The troubled entity must focus its attention on cost rationalising including staff reduction, renegotiation of rent, etc. There are many ways to mitigate the impact on the cash flow and conserve cash for a troubled entity in any industry.
Also, it should try to convert the fixed costs into variable cost i.e., seeking such resources on-demand. If any cost head becomes variable, there are chances that it may become expensive and may not be available on demand, however removing those from the books will help to extend the runway for survival and take off. In troubled times, extending runway is an important preliminary act to turnaround the business.
b) Increase sales through diversification: Sales is everything in business. It is the testimony for the success of entrepreneurship. However, in troubled times, the sales is first to be affected. Increase sales do not mean to confine focus on existing products and services alone. It is essentially meant to convey that promoter should examine the ways and means they can increase the turnover. For instance, if the customer cannot come to the restaurant, the hoteliers must explore the ways and means to sell the meals to corporates and deliver the food to customer’s place.
Look at the capacities in a holistic perspective, every business has its own strengths and can be made to serve customers in the different context. The promoter should break the business into various profit centres and analyse the opportunities. In the downtime, the strategy is to recover the costs and serve to survive till the turnaround that can be witnessed.
c) Infusing Equity than increasing debt: In India, it is commonly found problem among the entrepreneurs that whenever they slip to distress, they prefer to raise bank fund to support sustenance. As we said earlier, debt has poor risk absorption capacity and it cannot support a turnaround in isolation.
In distress time, the entrepreneurs should look at exploring equity investment. There is value in your startup, but perhaps you’re not the one enough to facilitate it. Before you quit, ask yourself, “Does the idea add value?” If the answer is “yes,” it could be that you have been the visionary behind the startup, but what you need is talent and partnership to move your startup forward. There are people who are willing to partner with someone so that they can avoid the startup pain yet be part of ventures. Look for such opportunities.
Any start-up may undergo stressed time. It may be imposed by the external factors. Instead of brooding over the challenge, it is better to rewrite the financial strategy and look for ways to turnaround which may include taing equity also.