Startups and small businesses are facing a new host of challenges and opportunities in light of Covid-19 and its the financial repercussions. We write this blog to inform you, as a startup or small business founder, regarding the latest trends in the industry, and what you can do now to protect your business.
Trend No. 1: Financing Slow Down
Many of our clients were in the process of raising a pre-seed, seed, or Series A round in Q1 2020. Unfortunately, due to the financial impact of coronavirus on the markets, many angel investors, seed or Series A stage venture capital firms (“VCs”), or corporate strategy departments in BigTech have pumped the brakes on financing early stage companies, despite the availability of capital to deploy.
Deals are getting done, but at a slower rate and lower volume, and with increasing reliance on virtual technologies. Moreover, for those companies that are able to successfully raise during the time of coronavirus or shortly thereafter, slower growth will likely negatively affect the company’s valuation in deal documents. [FN1]
Second, in a time where financing is dry, startups can also expect investor-friendly terms accompanying the typical convertible note or SAFE note raise (i.e., heavy discounts, lower caps, higher interest rates, and robust side letters with pro rata rights/rights of first refusal, information rights, etc.)
Finally, there are concerns about whether a startup in the time of coronavirus should even be relying on the typical convertible note or SAFE note when raising less than $2M. If the economy is slow, sales cycles are longer, and employees are less productive, there may be more disputes between early-stage investors and startups when it comes to meeting various milestones and financial targets, leading investors to decline conversion and insist on repayment. The startup may not have the funds to repay. For this reason, it might be worth reconsidering priced rounds at this time, which allow less ambiguity about what happens in the future.
Trend No. 2: Taking out a Small Business Loan and/or Tax Filing Relief
As a result of the fact that many of the expected funds from raising a round are no longer in play or are delayed, at best, many startups and small businesses are looking to small business loans to help with expanding their runway. The Coronavirus Aid, Relief, and Economic Security (CARES) Act includes a Small Business Interruption Loan program. The program would:
To qualify, a small business or startup would need to show that: (1) the business was operational on February 15, 2020, and (2) the business had employees for whom it paid salaries and payroll taxes, or paid independent contractors, and (3) the business has been substantially impacted by COVID-19. [FN2] Sources indicate that business owners won’t have to provide personal guarantees or use all their available assets as collateral. There are no fees, and interest rates are capped at 4 percent. [FN3]
In addition to loans offering liquidity, companies may take advantage of delayed tax payments. The IRS recently provided guidance in “Notice 2020-18 federal income tax return filing and payment relief” of measures corporate taxpayers can take in response to Coronavirus. According to Eisner Amper:
“[A company] ... with a federal income tax return or payment due on April 15, 2020, is eligible for relief under the Notice, including the postponement of the filing and/or payment due date to July 15, 2020 … The payment due is both 2019 federal income tax payments (including payments of tax on self-employment income) and 2020 estimated federal income tax payments (including payments of tax on self-employment income), regardless of the amount owed. The return in question must be due on April 15, 2020 – the relief does not apply to federal income tax returns and payments due on any other date. A taxpayer does not have to be sick, or quarantined, or have any other impact from COVID-19 to qualify for the relief. One only needs to have a federal income tax return or payment due on April 15, 2020.” [FN4]
Regardless of financing options though, startups and small businesses should heed the advice of Sequoia Capital, and look for ways to cut costs,”shop around,” and negotiate invoices from third-party service providers. [FN5]
Trend No. 3: Inclusion of a “Corona Clause”
Whether in loan agreements or in covenants in merger or acquisition legal documents, you can expect the use of a “Corona clause,” or a clause that takes into effect the negative ramifications of Coronavirus on a company’s business.
For example, specifically in negotiating loan agreements, this clause might have the effect of allowing companies to add back in lost profits or anticipated revenues that were not forthcoming due to “an extraordinary, unusual, infrequently occurring or non-occurring loss, charge, or expense” (i.e., Coronavirus).
In the context of an acquisition, a selling company’s representations or covenants might include a “Corona clause” that allows for sudden and/or unanticipated Corona-related changes that could materially and adversely affect the company’s business, financial condition and operations. There may be risk-shifting provisions from buyer to seller in acquisition documentation to account for unexpected ramifications of Coronavirus. Finally, companies should consult with counsel regarding whether to sell in part or in whole, based on the current climate and the foreseeable effects on business.
Trend No. 4: New “Hot” Verticals
In the time of coronavirus, certain verticals with disruptive technologies may be spared the otherwise uphill climb of financing. If you are looking to either start a company or pivot, it might be worth investigating these predictably “hot” verticals, including:
This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.