You don’t need a degree in economics to know we’re having a bad year. With staggeringly high inflation rates, rising interest rates and a stock market that’s had a horrible six months – the worst since 1970 – it’s no surprise that the word recession is being thrown around pretty liberally. Add to that alarmingly high energy prices and a battered supply chain, and it’s no wonder many businesses are becoming concerned, especially those in the emerging industries market, which is populated by startups just getting their funding and, for the most part, operating at a loss.
As companies in the cannabis and psychedelics sphere struggle to balance their cash flow with increasingly cautious investors, the future of these industries could seem uncertain.
At a time like this, it’s essential for emerging industries – including esports and clean tech – to focus on business fundamentals and cash flow. This is the time to meet with a solid financial team to decide what changes can be made to secure a bright future well after the economy stabilizes.
Understanding the emerging industry boom
As an entrepreneur in the emerging industries sector, there have been many causes for optimism before the economic decline.
Companies taking advantage of Canada’s legalization of cannabis initially saw incredibly high valuations – some that surpassed $1 billion – as investors jumped at the chance to buy-in to the seemingly lucrative sphere.
Psychedelics startups also saw recent interest from investors as promising research came forward about psychedelics use in healthcare. Paired with loosening restrictions in Canada and changing public opinion, new clinics and research and development companies started popping up.
Esports is also enjoying a meteoric rise both in Canada and worldwide. Even with the pandemic, the industry had global revenue of US$1.1 billion last year. Needless to say, many entrepreneurs and investors are showing interest.
Clean tech companies are also worth a mention, as government and industry investments have boosted many startups developing sustainable technology in Canada. Since 2001, this sector has received $1.36 billion in funding from Sustainable Development Technology Canada, an arm’s-length federal fund. As both private and public sectors begin focusing on ESG the industry has continued to grow.
Why startups are getting worried
While many companies in the emerging industries sector have enjoyed a boom, the uncertain economy has made it a difficult time to expand and secure funding. In terms of market growth, speculative growth stocks are usually the ones that are hit hardest during a recession.
Psychedelic stocks, for example, have plummeted in the last 6 months. Major players in the market have seen their shares decline by over 60%. While there’s still interest in the industry due to the sheer potential of the use of psychedelics to treat mental illness, investors have become cautious, often limiting their investment to a small percentage of their portfolio.
The cannabis industry has also been struggling, both in Canada and the US. While investors rushed to fund the many cannabis companies that flooded the market after Canada and many American states announced legalization of medical and/or recreational cannabis, entrepreneurs struggled to compete with black market businesses, which didn’t have to face regulations, taxes, and issues with growing good quality plants on a large scale. It didn’t help that many of the initial valuations for these startup companies turned out to be over inflated.
While there’s still potential in the cannabis sphere, especially as more states prepare for legalization, recent numbers are worrying and venture investment in this space has decreased. Reports suggest that this year only 41 companies received venture funding, and they were only able to close on $294 million, less than a third of the amount of investments earned by Cannabis companies in the first half of last year. With those numbers, we may see the worst funding year since 2017. Like the psychedelics sphere, cannabis stock has taken a huge hit. Companies who are still surviving are starting to cut costs and lay off staff to stay competitive.
In general, this same story is playing out for many emerging industries startups, including esports and clean tech companies. Even without the specific issues seen in the cannabis sphere, emerging industry startups have several things in common – many companies aren’t profitable yet and we’ve entered an era of cautious investors who are going to be careful where they spend their money. This could lead to lower valuations and less venture capital funding.
How to survive and thrive in a difficult economy
While startups are facing incredible difficulties right now, all is not lost. This is the time to return to the fundamentals of running an emerging industry business and review your company practices and structure. It’s essential to meet with your financial team to see what’s working and where you need to pivot. An experienced, dedicated financial firm, like Zeifmans, can help you thrive.
Business planning and compliance:
This is critical in any recovery plan, as it allows businesses to understand long-term opportunities and ensure they’re up to date with changing tax laws and regulations, something especially important in the emerging industries field. Your financial team can identify growth potential and ensure compliance practices are current. They can also review your corporate structures to check if they’re still beneficial in the current environmental climate.
Reviewing your entire business model is also a good move. Your original business plan would have taken into account the market at that time. Ensure your plan considers a potential recession and understand what changes you would need to make in that situation. Your review should include gross margins, net margins, your channels and markets, your sales, inflation rates and your customer base.
While reviewing your plan, be sure to take the following into account:
- Higher transportation and raw material costs
- Canada’s labour shortage
- Rising energy costs
- Inflation rates
Understanding financing options
Even with a struggling market, innovation and growth is still an important part of recovery efforts. Finding new forms of revenue will help safeguard your company if current revenue streams decrease. To do this, you’ll likely need continued investor and loan funding. Investors in the emerging industry sphere will be looking for companies with continued cash flow who have enough capital to survive for the foreseeable future.
Banks and other financial providers will require a solid business plan that takes the current climate into account.
For fast capital, review your assets to look for non-essential components that can be converted to cash such as land held for expansion, old equipment, or unused patents or trademarks. Look at possible sale/leaseback transactions as well.
For quicker funding, it’s helpful to understand what banks are looking for and be prepared for the application process. Lenders will be expecting entrepreneurs to prove they understand the financial metrics banks use. Our Zeifmans advisors can answer common questions lenders will have, like burn rate, sustainability of earnings, inventory turns, and forecasted monthly cash flow.
Your advisors can also help you leverage tax credits and government funding programs like SR&ED, which provides funding to research and development efforts.
What to know about managing your cash flow
Nothing kills a startup faster than running out of money, which is why understanding how to manage cash flow is an essential step to achieving profitability. It also helps lure investors, who are looking at cash flow more intensely than they have in the past, especially when dealing with emerging industry startups.
To start, it’s important to update your cash flow forecast, using both historical financial information and current financial trends. A great deal of skepticism in respect of the future is required. If cash flow is particularly tight, it’s a good idea to review your forecast daily or weekly. Longer-term reviews are also useful and are typically done monthly.
During these reviews, you should analyze your cash burn, review non-essential/discretionary spending, centralize control of the cheque book and reduce authorities who have spending power. In addition, review labour costs, layoff opportunities and work-share programs. You can also look at supplier/customer revisions on terms of payments and explore previously untapped government programs.
Each service or product should be analyzed to ensure it’s profitable and worth pursuing. If you notice certain services or products are more popular than others, it may be time to focus on those and cut out anything that’s tying up capital without providing a return. Not infrequently high growth divisions or product lines are voracious users of cash. Consider putting temporary restraints on growth.
Ensuring your supply chain is well managed is an essential part of cash flow management.
This is also the time to review your investment terms and interest rates on any loans. Higher interest debt should be repaid first.
To improve cash flow, finance big purchases and long-term assets instead of using current capital. It’s also important to properly plan any future financing needs so you’re not caught unprepared during a financial crisis.
It’s also a good idea to ensure your financial reporting is current so that it is available when funders request it, and to make sure you meet any reporting requirements. You don’t want to miss an opportunity to raise capital because your numbers aren’t ready or your audit isn’t done yet.
Surviving an ominous economic forecast
While the current economic forecast looks grim, emerging industry startups can still thrive if they take the right steps. From reviewing your business plan to helping you manage cash flow and understand what investors and lenders are looking for, to auditing your financial statements or providing accounting assistance, Zeifmans has decades of experience helping businesses thrive in uncertain times. Contact us to speak to an experienced advisor.