Founders, fear and hibernation: Seven reasons startups should not make employees redundant

A crucial, common feature of startups is that they burn cash. The best of them grow hyper-fast and rely on raising capital to fuel their growth. The COVID-19 pandemic is thus an existential threat to most startups, including the good ones. It hits them with a triple whammy.

1. Raising capital in the short to medium term has become near impossible.

2. They are generally unable to borrow due to weak balance sheets and the absence of personal guarantors.

3. They face drastically shortened cash runways due to pandemic-induced revenue reductions.

Across the world and across Australia, startups are scrambling to survive by cutting costs steeply to extend their cash runway.

The sad thing is that since staff costs typically represent >80% of the fixed costs of a startup, ‘extending runway’ has become a euphemism for firing staff. Often having great people and a great business model does not mean you can make payroll if the impact of the pandemic either worsens (as it is) or continues for several more months.

If a business which is burning cash cannot keep staff busy with activities which are cash-generating in the short term, what choices does it have?

Given crisis conditions, it is folly to be paying staff who cannot contribute to short-term revenues, irrespective of whether they are critical to the longer-term success of the business. (Development teams are likely to be particularly hard hit by this situation.)

The result? There is already a swell of redundancies which could become a tidal wave among startups unless founders and CEOs do a mental switch from cutting staff to hibernating them.

The crisis we are currently facing is only temporary, but redundancies do permanent organisational damage. ‘Hibernating’ staff who are not contributing to short-term cashflow provides much better outcomes for both the employer and employee than the knee-jerk alternative of making staff redundant. Hibernating staff simply means temporarily reducing paid work hours per week or implementing leave purchase plans or (in extreme cases) asking some staff to take unpaid leave.

Leave purchase plans are often the fairest and useful tool for implementing staff hibernation. Such plans are common in the public service.

They involve staff ‘buying’ additional annual leave with the ‘cost’ of the extra leave days ‘paid’ for as a salary reduction. By agreement, the extra leave days may be taken while there is little work for the employee to do.

The result is that employees can effectively be on unpaid leave when not needed but their income continues (at a reduced rate) throughout the year.

This arrangement can dramatically cut employment costs whilst leaving idle employees with cashflow to pay their bills.

Hibernation offers large advantages both for the startup and its staff.

There are numerous reasons why hibernation is a vastly superior crisis response compared to redundancies. Here are seven.

1. Humanitarian

Having a job with reduced hours and income, or even enforced leave, is massively better (both financially and psychologically) than simply being made redundant.

Why?

1. It preserves an ability to pay bills.

2. It preserves self-esteem and engagement with the world (as compared to sitting at home permanently ‘unemployed’).

3. The psychology of temporarily working fewer hours or being on leave (which will automatically reverse as the crisis subsides) is different and much less stressful than not knowing whether/when you will get another job.

4. A small percentage of people may actually prefer/enjoy reduced working hours or taking leave for a while.

5. At a time when public morale is low and jobs are rare, firing people should be the last resort.

2. Cashflow

Making people redundant incurs an immediate cash payout of employee entitlements. Shifting them temporarily to reduced hours or unpaid leave until things get better does not.

3. Granular responsiveness

A hibernation strategy enables a very granular and adjustable response to dealing with rapidly changing circumstances.

The working hours of different categories of staff, or even individuals, can theoretically be flexibly ramped up and down as needed. In practice, this requires a deep understanding not just of business needs, but also the financial and emotional needs of individual employees.

The fact that startups tend to be smaller and more personal than traditional businesses gives them an advantage in navigating these issues. Workloads can be job shared, paid leave taken and ‘leave purchase’ plans implemented.

4. Culture

Counterintuitively, shifting teams to reduced working hours (if correctly handled) can actually provide a boost to staff engagement. It can end uncertainty and demonstrates in a practical way that the business is doing everything it can to avoid firing people.

1. Empowering staff to choose to ‘share the pain’ in order to save jobs can build good team morale and employer loyalty.

2. Evidence from past recessions is that teams may be motivated to actually work harder than before (despite reduced paid hours) in order to help their employer pull through.

3. There is evidence that some categories of worker respond to reduced hours (especially if work from home is possible) with increases in productivity and reductions in churn.

5. Resilience to rebound

The true total costs associated with recruiting, training and ramping employees are generally much underestimated.

Using hibernation to cut costs during a crisis enables a business to scale up its workforce again much more cheaply than if it had fired trained people.

When things start improving you can flexibly scale up the work hours of your trained staff to meet demand instead of being distracted into the time-sucking tasks of recruiting, interviewing and training.

6. Goodwill

Employees who have been made redundant are rarely positively inclined towards their past employer.

In past downturns, employers who have tried hard to keep employees through hibernation have emerged with much better reputations than their peers both as employers of choice and as good corporate citizens.

7. Societal

In a crisis, founders and CEOs are rightly focused on cashflow and survival. But from the broader societal perspective, the economic bounce back from the crisis is significantly lessened by the widespread adoption of job hibernation.

Instead of mass unemployment, we would have more underemployed workers who can ramp back to full-time work as the economy strengthens.

The vast difference this makes in all aspects of our culture, not the least being mental health, cannot be overstated. A faster bounce back benefits all.

Founders, fear and hibernation

Australian industrial law does not contain clear mechanisms permitting employers to enforce the hibernation of employees.

In the spirit of the recent change to insolvency law (those designed to enable directors to be bolder to continue trading during the pandemic), industrial law might be amended to make it easier for employers to hibernate staff.

Meanwhile, founders require imagination, courage and leadership skills to implement a hibernation strategy. Unlike simply resorting to redundancies, implementing a hibernation strategy involves more risks, judgment calls and persuasiveness.

The risk is that to the extent that founders cannot secure the support of some employees those employees could, theoretically, argue they remain entitled to full pay or were wrongfully dismissed. However, three factors are likely to make this risk more theoretical than practical in the case of startups.

1. The impact of the coronavirus is such that it will often be possible (and necessary) to make employees redundant unless there is widespread co-operation with the implementation of a hibernation strategy.

2. Startup culture is such that, with proper leadership, employees are more likely to support short-term measures to ensure the survival of the business and the preservation of their jobs for the longer term.

3. The vast majority of startup employees have a short tenure of employment limiting the potential damages in the event any of them pursue wrongful dismissal claims. Additionally, industrial tribunals are likely to be sympathetic to employers who have acted in good faith to stay afloat and preserve jobs.

“Fortune favours the brave.” In short, my advice is don’t fire, instead, hibernate!

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