Start-ups Weathering the Covid Storm

Tech companies / start-ups were instrumental in the economic rebounds post the last two global economic crisis. Smart money suggests that they will be fundamental once more in our recovery in a post-Covid-19 pandemic world. For existing businesses, how do they remain afloat in the present as they weather the storm? For the brave new start-ups and entrepreneurs, what should they think about before diving into this new economic landscape?

The Covid-19 pandemic is shaking things up globally. The start-up scene, the early success story of the 21st century, has not been spared. In March 2020, the Startup Genome released a report of its survey of over 1,000 startup founders and executives across more than 50 countries on the impact of the Covid-19 pandemic on startup ecosystems. This was followed on 25 June 2020 by its Global Startup Ecosystem Report 2020.

These reports give a sobering snapshot of the fortunes of start-ups in the face of the Covid-19 pandemic, with a significant proportion experiencing an existential crisis: sudden disappearances of consumer demand, funding droughts (most start-ups will run out of money within 6 months, with 4 out of 10 start-ups having 3 months or fewer of capital runway), disruption to supply chains (1).

However, not all is doom and gloom. Despite the apparent bleak situation at present, the Startup Genome reports do provide some findings which paint a hopeful future of the start-up ecosystems. Hopefully for us, this will mean that Asia-Pacific will continue its rise in the start-up scene, which has gone from having 20% of top ecosystems in 2012 to 30% of them today (2).

Every crisis creates opportunities, and this crisis is no different. History might provide some comfort: over half of Fortune 500 companies started during a contraction, and over 50 unicorns were created in the Great Recession alone (3). It is clear that start-ups and entrepreneurs able to quickly reposition themselves or seize available opportunities will find themselves placed in steady footing to weather the crisis, with some even geared to come out stronger. The success of any repositioning or new enterprise will very largely depend on the ideas that germinate in an entrepreneurial mind. The world however does not stand still and wait on you. What do you do then to hold the fort during this economic crisis while you transition your company? Or if you do set up a new business, how do you ensure that you give yourself the best possible chance for success?

Below, I set out a few (hopefully) short points of options you may consider. Some are gleaned from my experience in advising some clients, most from observing what other clients have done / are doing and recalling conversations I’ve had with other more learned lawyers.

Weathering the Storm

I have been holding out for a Covid-19 Bill for the longest time, but as at 22 July 2020, it is still purportedly being drawn up. Hopefully, if and when such a law comes to pass, there will be some effective laws introduced, founded upon sound policies, to help us weather this storm.

In the meantime, these are some options you may consider adopting to stay afloat.

(A) Debt recovery

These may be debts owed to you or your company pre-Covid-19, or which may have been brought on by the pandemic. Either way, while it is important to understand where the other side is coming from, you and your business need to be paid in order to stay afloat.

Any pursuit of debts should start with a legal demand letter. Often, parties will come to an amicable arrangement shortly after. However, if that is not possible, several options are available to you, which is set out in this helpful infographic. Winding-up has never been a preferred option for me when advising clients as you have to rank evenly with other creditors, but this is more so now that there is an effective “freeze” in the winding-up process until 2021(4). My preference would be the debt recovery options to seize the assets (including bank accounts) of the debtor company, however these first require a Court judgment. In a straight-forward case, you should be able to obtain a summary judgment within 3-5 months.

(B) Cost cutting measures

These can range from increasing energy efficiency to employee job-reallocation. However, the focus of this section is on what is typically the biggest cost of start-ups: employee wages.

Options to consider are temporary wage cuts and mutual / voluntary separation schemes, for which you will be required to obtain the employee’s agreement. However, businesses also retain a right to reduce its workforce by reason of redundancy (in simple terms, there are more employees than there is work) necessitating retrenchment. In such a case, the Courts will typically defer to the management’s right to reorganisation, provided it is genuine and not a mere front for termination.

(C) Alternative source of funding

Traditional funding through bank loans and from funds is not as readily available at present. However, there are alternative sources of funding or fund-models you can explore. I wrote about the viability of interest schemes as an alternative form of fund-raising, where investors can put in money in return for a share of future profits – you can retain your equity. A start-up’s scheme model need not be in the size of say, a palm oil interests scheme, but elements of such an interests scheme can be adopted to suit a bespoke funding scheme to raise capital for a much smaller start-up. With banks currently offering much lower interest rates, a lower than usual return rate on such schemes may tempt sufficient retail investors to crowd-fund an enterprise. This would be novel, and highly interesting.

(D) Cutting loses (for companies)

If the debts are beyond manageable, it may be high time to consider a form of debt restructuring (schemes of arrangements and judicial management). In the extreme, moralities aside, you may wish to consider winding-up your company, cut your losses and return to fight another day. Unless you have been involved in fraudulent trading or have given a personal guarantee, typically, the liabilities of a company will not be extended or transposed to the shareholders. However, a very real concern is the value of goodwill attached to your brand name and business, and whether a prior winding-up will heavily impact on any new ventures you may wish to undertake.

A New Hope?

What if you are instead thinking of setting up a new company or enterprise, taking advantage of the various voids left in the aftermath of the Malaysian MCO lockdown (5)? The 3 things off the top of my head are these.

(A) Company, sole proprietor or a partnership?

First, you need to consider how you intend to carry on such business: using an incorporated company, as a sole proprietor or in partnership with others. These will have various implications ranging from tax applications to, critically, matters of liability. For companies and partnerships, what is highly crucial is the underlying contract between owners in respect of the ownership and running of the company / business. You should not skim this stage – they are a large cause of internal breakdowns in businesses.

(B) Funding, licencing and franchising

Second, how are you going to fund your business. If funding is going to be an issue, you should consider looking at licences and franchises, which I wrote about here. The upshot of such a business model is that you can ride on the existing brand recognition to jump start your entrepreneur career, especially if you are new to running your own business. It may not be a terrible time to look to bring in international brands, ideas or tech to Malaysian shores, with international businesses also looking for opportunities to expand.

(C) Fixed-term employees

Third, the issue of staffing. If you are not able to commit to hiring long-term employees, consider fixed-term ones instead. The upshot of fixed term employment contracts is that at the end of the term, it gives you the flexibility of whether to renew the contract or for parties to go their separate ways (6). The downside, employees may be far more expensive later down the road.

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(1) We are of course not referring to companies so perfectly designed for life in lockdown, which have seen revenue and market share increase multi-fold. While three-quarters of start-ups report some form of revenue decline, 26% have seen their revenues increase during the crisis. In consumer-facing (B2C) sectors, 15% of startups are “experiencing growth.”

(2) Global Startup Ecosystem Report 2020, p 17

(3) Global Startup Ecosystem Report 2020, p 24

(4) In a straight-forward debt recovery, a creditor company will issue a statutory demand for the debtor to pay the debt within 21 days, failing which the creditor company will have basis to commence winding-up proceedings. However, by way of the Companies (Exemption) (No. 2) Order 2020, a debtor company now has 6 months to pay on such demands. The Order is presently being challenged in Court.

(5) This infographic from WeCorporate shows a marked increase in new enterprises being registered.

(6) Provided you have not given your employee basis for a legitimate expectation that the contract will be extended.