COVID-19 is changing key business relationships

That makes this crisis different from past ones

Credit: Chris Gash

Waverly Deutsch

Waverly Deutsch | Aug 27, 2020

Sections Entrepreneurship

Collections COVID-19 Crisis

No entrepreneur is a stranger to crisis. Whether it shows up as a key partnership falling apart right before a contract is signed or a global economic downturn, crisis is a fundamental part of entrepreneurship—and, in fact, often accelerates the adoption of technology and market innovations. Following the 2000 dot-com crash, the e-commerce, social media, and interactive-web-experience sectors boomed. After the 2008–09 global financial crisis, giants of the gig economy, including Uber and Airbnb, emerged and became unicorns with multibillion-dollar valuations. Analysts are already speculating about what industries and companies will be the winners post-COVID-19. Will telehealth, remote working, online education, even micromobility (transportation for one) become the new norm in a world fearing the next pandemic?

In past economic downturns, the main concern for startups was cash flow, which was stressed by longer sales cycles, lower equity-capital availability, and more-difficult-to-access debt. Entrepreneurs who could run lean and wait the crisis out emerged stronger, as evidenced by increased survival rates for companies in the years following recent crises. (For more, read “Surprising numbers behind startup survival rates.”) 

Researchers typically look to past crises for forward-looking lessons that can help ameliorate the damage of the next crisis, but the global pandemic of COVID-19 is different. It is not a regional crisis, as was the case for Hurricane Katrina, which shut down the economies of southern Louisiana and much of the Gulf of Mexico coast for months. Nor is it a purely financial one, such as the 2008–09 global financial crisis. COVID-19 is the worst combination possible, disaster plus economic crisis, and it is worldwide. With its shelter-in-place and social-distancing mandates, it is fundamentally changing key business relationships.

Early impacts of COVID-19

Although the COVID-19 crisis is still in its early days, I wanted to see what entrepreneurs were already experiencing, so in June, I surveyed 46 entrepreneurs. Twenty-one were based in the United States and 25 were international, with representation from Australia, East Asia, Europe, India, Mexico, and Singapore. Half ran companies more than five years old, and 22 percent ran companies less than two years old. Most of the companies had revenue of under $10 million annually, with four over that amount and 10 still pre-revenue. Twenty-one companies in the survey were small, with fewer than 10 employees, and only five had more than 100 employees. I asked whether these companies, because of COVID-19, had been affected by any of a range of issues related to revenue, access to capital, human resources, or supplier and customer terms—19 issues in all.

The picture that emerged was mixed. By and large, the companies I surveyed were not in a capital crunch—at least they weren’t yet. Only five entrepreneurs reported needing capital and being unable to obtain it. Two of these had tried, unsuccessfully, to access the US government’s Paycheck Protection Program, but nine entrepreneurs had been able to access PPP funds or their country’s equivalent, and another three reported that they’d secured the capital they needed from other sources. 

A handful of companies had seen credit terms change with suppliers and customers, but those terms had changed more often in their favor than in that of their suppliers or customers.

Entrepreneurs’ pandemic response

A survey of 46 entrepreneurs suggests that the COVID-19 crisis may not be following the pattern of recent economic downturns.

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More companies reported changes in their product mix, supplier base, customer count, employee situation, and revenue—but here, too, the results were mixed. While nearly twice as many companies had seen an atypical decline in revenue than an atypical increase, about the same proportion had added to rather than discontinued offerings from their product mix. And a quarter of the entrepreneurs reported that the COVID-19 situation allowed them to hire talent they would not have been able to access in a typical market. Less than 20 percent of the companies had made layoffs.

When I sorted companies by predominantly positive impacts (accessing capital, adding talent, increasing customers and/or revenue) versus those with mainly negative experiences (failing to get needed capital, experiencing layoffs or declines in customers and/or revenue) and those with mixed results, the sample split nearly evenly, with just a few more companies thriving than suffering.

Startup funding during crises

While I expected companies in some sectors such as health care and grocery to do well in the pandemic, the picture that emerged from the survey surprised me. The positive experiences many entrepreneurs reported having may be in part due to the fact that we are still in the early stages of this crisis. 

In many if not all crises, the effects take time to surface. For example, after the March 2000 tech crash, seed and angel-investing levels initially remained high. In 2000, 532 deals raised $1.7 billion, which represented a small drop off in the number of deals made in 1999 but an increase in the dollar amount. Both the number of deals and the amount of capital they involved dropped off substantially in 2001, and then bottomed out in 2002 and 2003, during which time a total of 70 seed and angel deals were reported, raising a mere $84 million. A similar picture emerged for later-stage venture investing after the tech crash. 

In contrast, the 2008–09 global financial crisis did not impact angel and VC investments as severely. In fact, deal volume and investment amounts were slightly up in 2008 compared with 2007. While Series A and, later, deal flow and capital investment dropped off by nearly 25 percent in 2009, both began growing again in 2010 and were totally restored by 2011. Angel and seed investing didn’t miss a beat, with over 60 percent growth in the number of deals and 85 percent growth in capital invested in 2009 over 2008, according to the PWC MoneyTree interactive data set. 

From an equity-capital standpoint, which will the COVID-19 crisis look more like: the disaster that followed the tech crash, or the ho-hum, business-as-usual impact of the 2008–09 global financial crisis? Recent data from a survey of 451 young venture-backed companies and 141 VC firms by NFX, an early-stage VC fund in San Francisco, reveals that US-based founders and investors have different views on how this crisis will affect the startup ecosystem. Half of venture capitalists report that they are extremely worried about the fate of their portfolio companies, more than the 44 percent of founders who say they’re not at all worried about their own prospects. Perhaps these results reflect when each party thinks the crisis will be largely resolved. Sixty-five percent of founders say they need 18 months of capital or less to survive the downturn, but 49 percent of investors think their portfolio companies will need money that can last them longer.

A unique impact on relationships

This pandemic-created crisis may not follow the pattern of recent downturns at all. COVID-19, beyond creating financial uncertainty, is fundamentally altering how startups operate. In-person businesses such as consumer services and retail companies have been required to stop engaging with customers for extensive periods of time and to implement health measures and reduced contact for the foreseeable future. Companies in huge white-collar sectors, including business services and technology, have been forced to enable their employees to work from home, which in some cases has required big investments in technology infrastructure and changes to workflow and management processes. And essential, labor-intensive industries such as manufacturing, health care, grocery, and agriculture are being stressed by ineffective health precautions that leave their employees vulnerable to the disease.

Given the need for less in-person contact, every critical relationship an entrepreneur must develop and maintain has changed. I asked our survey participants about their relationships with their board of directors, investors, suppliers, customers, employees, and fellow executive-team members, to understand if these relationships had changed, and how so. Only 13 percent of the entrepreneurs reported no changes, while two-thirds said relationships with employees and customers were different.

For 15 percent of the entrepreneurs, the mere fact that all communication has now become virtual constituted a relationship change. Some cited a need for more-frequent communication to maintain relationships, and others talked about needing more morale and team building to keep employees connected and engaged. Just under a quarter had to change suppliers, and many were spending more time negotiating with their partners, oftentimes seeing that both sides were demonstrating more flexibility than usual. For many survey participants, COVID-19 has lengthened sales cycles and increased the importance of customer service, while others stressed the need to be flexible on pricing, terms, and fulfillment processes.  

Entrepreneurs’ relationships

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Interacting with each of these constituents may, in some ways, have changed forever. Sixty percent of investors told the NFX survey team that even after the crisis was over, they would be willing to fund a company without meeting the founding team in person—despite the fact that over half of them had never done that before. This represents a huge change to the critical formation phase of such an important relationship. In the B2B sales world, Mary Shea, principal analyst with Forrester Research, forecasts that in-person meetings may decline by as much as 80 percent post-COVID-19 as companies discover that digital interactions are effective and much less costly. 

Can your employment strategy predict your post-COVID-19 future?

Remote work will be a significant trend beyond the immediate crisis. An IBM Institute for Business Value survey of 25,000 American consumers reveals that over half would like to continue working at home full time, and 20 percent want the remote option some of the time. Entrepreneurs are preparing for this eventuality. Nearly three-quarters of founders expect that their workforce will be majority or fully remote after all shelter-in-place restrictions are lifted, according to the NFX research.

My survey dug a little deeper, specifically into how COVID-19 is affecting entrepreneurs’ human-resources strategies. I used a framework developed by Yale’s James N. Baron and Stanford’s Michael T. Hannan for a research project called the Stanford Project on Emerging Companies (SPEC), which tracked nearly 200 technology startups launched between 1989 and 1996 through the 2000 tech crash. Baron and Hannan created organizational models, or what they termed employment blueprints, using three elements: the primary factors in selecting talent; the basis for coordinating and controlling work; and the reason employees felt an attachment to the company and stayed with it. By looking at common combinations of selection, control, and attachment dimensions, they suggest that most high-tech startups use one of five models.

Entrepreneurs’ employment strategies

Survey respondents’ companies mostly lined up with the star blueprint for tech startups, as defined by the Stanford Project on Emerging Companies.

Five models of hiring and employee management

Star

Commitment

Bureaucracy

Engineering

Autocracy

Primary factors in selecting talent

Talent and potential

Values and cultural fit

Skills and experience

Skills and experience

Skills and experience

Basis for coordinating and controlling work

Professionality

Culture/peer pressure

Formal processes

Culture/peer pressure

Metrics and monitoring

Reasons employees feel an attachment to the company

Interesting work

Love of culture/team

Interesting work

Interesting work

Excellent pay

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Startups with a star model of employment rely on highly talented people who are motivated by challenging, interesting work. Those with a commitment model stress culture and strong team bonds to move the company forward. Companies with an engineering model focus on dedicated people with great skills, who essentially manage each other. Bureaucracy companies pair well-qualified employees who appreciate challenging work with more-formal management that uses processes and procedures. And entrepreneurs managing employees via the autocracy model see people as motivated by money and in need of direct supervision.

Baron and Hannan discovered some interesting correlations by following companies through both boom and bust cycles. In the key areas of survival and outcomes, two models outperformed the others: star and commitment. Companies using these models were the least likely to fail—by large percentages—versus the engineering and autocracy models. And, while companies using the star blueprint saw substantially larger annual market capitalization growth, commitment companies were by far the most likely to exit by initial public offering.

I eliminated four companies from my sample that had no employees, and used Baron and Hannan’s coding method to organize the remaining 42 companies into their employment-blueprint models. Unlike the companies in the SPEC sample, a majority of my participants fell into either the star or the commitment model. I have no answer as to why the two samples would be so different in that respect, but hopefully this bodes well for the founders in my survey. 

Entrepreneurs in my sample leaned heavily on fit and potential for talent selection, professionality and metrics for control, and the work and culture for attachment.

Entrepreneurs’ human-resources priorities

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When asked if any of these strategies had begun to change because of COVID-19 and the new remote reality, 40 percent said no. The one area where many entrepreneurs seemed to be making changes was to their management tactics, or how they controlled and coordinated work. Many with more-structured management styles that involved metrics and monitoring reported having to offer employees a bit more flexibility, and to be more aware of employees’ personal situations. By contrast, some founders who had been relying on the personal professionalism of their employees or peer pressure to ensure the job was getting done found themselves putting more emphasis on communication and metrics. 

In the comments section of a question, only one entrepreneur reported that workers seemed less motivated since the beginning of the crisis (and attributed it to the government offering higher-than-usual unemployment payments), but six mentioned that employees seemed increasingly loyal. These six may have discovered an important lesson. After the survey, one told me this story: 

When I took the survey, I wasn’t very worried about cash. I am now. Our pipeline sucks. Our company will survive, but something will need to give. In any other time, I would have talked this through with the team. Instead, I took a big salary cut and kept running the numbers. I was stressing out, not sleeping, and not being honest with my team about the toll it was taking on me. I finally decided I just had to solve it myself. 

I was about to lay people off while I could still afford severance so I wouldn’t have to make across-the-board pay cuts. Before I met with my team, I thought, “This isn’t right. It’s not who we are. We value transparency and team problem-solving here.” So, instead, I called everyone together and told them exactly where we were and gave them three options: (a) take pay cuts, (b) voluntarily exit with severance, or (c) do nothing and hope for the best. I expected the tears, the sadness. What I did not expect is that not one of them was scared about his or her job. And not one of them wanted the severance option. Their concern was for the company. They all wanted to stay and figure it out. Now they are talking to their families about what kind of a pay reduction they can manage. 

Long story short: crisis makes you panic. When you panic, you think you have to do something and you make mistakes. But this is why you created your company values in the first place. They work in hard times, not just in the good times.

One key takeaway from Baron and Hannan’s research is that trying to change your employment-blueprint model is destabilizing. In the companies that they observed making big changes, employee turnover grew, valuations suffered, and failure rates increased by more than 200 percent. All of this may provide a warning for entrepreneurs in the time of COVID-19: in this crisis, which is altering relationships in unprecedented ways, your product, supplier, and customer mix may change permanently. But when it comes to one of your most critical constituents—your employees—you may want to stay the course. After all, these are your people, and you are in this crisis together.

Waverly Deutsch is clinical professor at Chicago Booth and the Polsky Director of the UChicago Global Entrepreneurs Network.