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Lessons from Recessions Past

When the Great Recession hit in late 2007, the marijuana industry showed little resemblance to what it is today, with only a few cannabis businesses operating now that were open then. Today, thousands of growers, retailers, manufacturers and ancillary companies operate across more than 30 states—and they now confront a major economic downturn.

For many in the cannabis industry, this might be the first recession they’ve faced as an executive—or even as a professional. Steering a company or business unit through any recession is daunting, especially one of this magnitude.

Nevertheless, past recessions can offer lessons for how to cope. To that end, Marijuana Business Magazine assembled a quartet of cannabis executives who have weathered the nation’s past three recessions:

  • The savings and loan crisis of 1990-91.
  • The dot-com bust of 2001.
  • The subprime mortgage debacle of 2007-09.

These four executives share lessons they learned from previous recessions and how they are applying them to the current downturn.

 


Pam Marrone

Founder and CEO, Marrone Bio Innovations, Davis, California

 As head of Monsanto’s Insect Biology Group in the 1980s, Marrone pioneered the field of biopesticides and leveraged that experience to become a serial entrepreneur. Lessons she’s learned from the past three recessions include:

  • Raise more money than you need during good times and don’t worry about dilution.
  • Investors who have lived through recessions will better understand your challenges than those who haven’t.
  • Executives and managers need to take salary reductions.
  • Balance cuts and growth opportunities.

Marrone started her own biopesticide company, Entotech, in early 1990 under parent Novo-Nordisk. A few months later, the nation fell into a recession, but Entotech was unaffected because food prices remained high and farmers kept buying its products.

Averting disaster wasn’t so easy in 2001, when Marrone was CEO of AgraQuest, a biopesticide company later acquired by Bayer for nearly $500 million.

“A Silicon Valley investor in AgraQuest said, ‘Plan for disaster. You just don’t know what’ll happen,’” Marrone remembered. She was left to wondering, “What’s going to happen?”

What happened was 9/11, just a few days after Marrone landed in New York City for the start of AgraQuest’s IPO roadshow.

 

Raise Money in Good Times, Dilution Be Damned

Consequently, Marrone, who built the company in anticipation of $50 million in proceeds, couldn’t close the offering and had to quickly cut costs. Simultaneously, venture capital markets “slammed shut,” forcing AgraQuest to compete with dozens of other companies for capital.

“You’re at the mercy of those giving you the money, and then you don’t get the best terms,” Marrone said. “In the good times, you want to raise more money than you need and not worry about dilution because you need it to weather.”

But raising money is often easier said than done—especially if investors are worried about dilution. Winning those battles is likelier if investors have been through a recession.

“Money coming from those who have gone through tough times and who’ve built businesses is often more forgiving than from those who have never been through it,” Marrone said.

 

Balancing Cuts and Growth

Experienced investors also are more likely to understand that abandoning future growth opportunities can be imprudent.

For example, after 9/11, some AgraQuest board members wanted to forgo European expansion plans. Marrone argued they were at the “cusp” of European revenues and pulling back would be “penny-wise and pound-foolish.”

“You don’t want to cut the long-term prospects of the company. But, on the other hand, you have to live to see another day,” she said. “It’s a really difficult balance.”

To convince resistant board members about pursuing revenue in Europe, Marrone reminded them that venture capital stakeholders in the company would need an exit at some point. As it turned out, the AgraQuest product Serenade became a leading biofungicide that later netted the company millions of dollars in revenue.

Marrone made cuts after 9/11, too. For example, she significantly reduced the marketing department and resorted to marketing “on the cheap.” She also asked AgraQuest’s upper-management team to take 10% pay cuts, although they all refused except for the chief financial officer.

 

Lessons Applied in 2007 and 2020

As CEO of Marrone Bio Innovations, which she founded in 2006, Marrone has applied the lessons she learned from previous downturns.

For example, she raised money during good times, including a Series A round in 2007, just before the market collapsed. “I would have gotten much worse terms—and maybe not even been able to raise” later—plus a 2013 IPO followed by several funding rounds.

Marrone is still selective about where she chooses to cut expenses. While many companies cut research and development budgets during recessions, she said only about 20% of her R&D budget goes to new product development while the rest goes to mandatory product safety, quality and manufacturing support. She also credits the R&D team for improving Marrone Bio’s operating efficiencies and taking the company from negative margins to margins of 58% since 2015.

“You have to look at what is essential and what is going to generate near-term cash from sales at a good margin,” she said. “What are you going to reduce without harming future growth? Because investors—this is in cannabis as well—they want to see a big, high-growth company.”

In response to board demands, Marrone cut 10% of her company’s budget. She did this by reducing senior executives’ salaries by 10% and replacing the difference with restricted stock units (RSUs). Bonuses for the top two management tiers—typically paid half in cash and half in RSUs—were paid all in RSUs, while pay increases were frozen throughout the company.

Marrone is better positioned than in recessions past, but she’s still concerned because commodity prices are down and farm bankruptcies are up, although she said sales to cannabis clients
remain steady.

“You just in general have to plan for disaster, which means raise money when you don’t need it,” Marrone said. “Get as much as you can.”

 


Ed Schmults

CEO, Calyx Peak, Foxborough, Massachusetts

This is Ed Schmults’ fourth recession, and while it might be more staggering than the previous three, thus far it has been the easiest to weather. Why? Because cannabis has so far proved to be recession-resistant, while products from his previous businesses were not.

Still, lessons from those earlier struggles inform Schmults’ decision-making today. For example:

  • Inspire confidence in employees and firmly set company direction.
  • Have a plan for moving inventory and streamline operations.
  • Capital is critical to moving forward.

 

Decisive Leadership

Consider Patagonia, the outdoor clothing retailer where Schmults was a business analyst when recession hit in 1990.

“Our planning had expected rosy season after season, and all of the sudden, it flattened out. The company just hit a wall,” Schmults recalled. “We didn’t see it coming, and the company was unprepared for it.”

Patagonia’s bank at the time, Security Pacific (which was bought by Bank of America in 1992), pulled Patagonia’s credit line. About 30% of Patagonia’s employees were laid off—including the entire C-suite team.

The company ushered Kristine McDivitt, a previous CEO who was still with the retailer but in a different executive post, back into the chief executive’s office, where she rallied the remaining staff.

“I’ll never forget the first meeting,” Schmults said, recalling how McDivitt called about eight leaders into a conference room “and just gave this unbelievable, inspiring speech … went around and said, ‘I want you to do this, and I want you to do this.’”

The lesson for executives: “You set the direction,” Schmults said. “If she told me, ‘Jump out that window.’ Boom, I was gone.”

“There’s the old adage, ‘don’t waste a crisis.’ The opportunity to rethink how to conduct business more effectively resulted in a healthier company coming out the other side,” Schmults said.

 

Improving Operations

Schmults emphasizes that while the human toll recessions take are never a good thing, downturns do offer opportunity for improvement. In 2007, he was in a similar situation as CEO of the iconic toy store FAO Schwarz when the subprime mortgage crisis occurred.

“I can point to the day: Oct. 30, our sales just fell off a cliff. I was also on the board of REI at that time, and the same thing happened to them. Those financial executives were our core customer, and they just got crushed,” Schmults recalled. “We suspected that the business was going to get tougher but not quite so abruptly.”

Nearly two decades later, Schmults had to do what his leaders at Patagonia had done, but in a much more difficult downturn.

“You have to get out from under your inventory burden and you have to reduce costs, which sadly involved layoffs,” he said. “I think the one lesson is always do more than you think you need. If you do it piecemeal, it’s just brutal for everybody involved.”

Another step is looking at supply relationships and bidding out costly contracts to make sure you get the best value. “When business is good, you don’t address a lot of those important, day-in, day-out aspects,” he said.

At FAO Schwarz, that meant assessing which vendors were making the most money per square foot of the store and whether the company’s transaction technology was the best fit for the company’s needs.

 

Capital Critical

Schmults was confident enough in his measures and the resulting plan that he offered to buy FAO Schwarz from its investors, whom he said eagerly accepted the idea. But after speaking with more than 50 investor groups, Schmults couldn’t raise enough money to buy the store.

“Nobody was investing in anything—it’s kind of similar to now,” he said.

While cannabis is performing better than toys and apparel, the current downturn has Schmults thinking about those earlier lessons.

“You’ve got to think about landlords, about your customers. Do they have jobs? Are they going to be cutting back? This may not hit cannabis until June or July—or manifest itself in a very different way.”

And even if sales stay solid, investor capital has dried up, Schmults said.

“All of our expansion plans require capital,” Schmults said. “In terms of maintaining the ship, continuing sales will do it. But in terms of expansion plans … you can’t do that just with sales. You need investors, you need capital.”

 


 

Al Foreman

Managing Partner and Chief Investment Officer, Tuatara Capital, New York City

Al Foreman was taking business and finance classes at the University of Connecticut during the 1990-91 recession. For Foreman, the downturn drove home his professors’ lessons about recessions being cyclical and watching certain economic indicators to gauge if a downturn is looming.

 

Cycles and Indicators

“Recessions are not only cyclical, they’re often predictable by patterns shown several years in advance,” Foreman said. “The lesson learned is try to identify where you are in the cycle, because it may impact the investment you’re making or a particular business decision that you’re evaluating.”

Among the key indicators to watch are:

  • Upturns in credit borrowing that signal a lending crunch.
  • Short-term bond yields are higher than long-term bond yields.
  • Lenient federal banking and finance policies.

“The past couple of years, we’ve seen increased borrowing on both the personal and corporate sides, which is an indicator that there might be choppier times ahead as more people get overextended,” Foreman said. He also noted that in recent years, the Federal Reserve has lowered reserve ratios (the amount of cash banks are required to keep on hand and not loan), which has allowed financial institutions to make more loans while also weakening their balance sheets.

As for inverted yield curves—when short-term bond yields become higher than long-term bond yields—Foreman said: “Pretty consistently, 12 to 18 months after you see the treasury yield curve invert, you find yourself in a recessionary climate.”

 

Risk, Company Performance, Credit Crunch

In 2000, Foreman left a well-paying vice president-level job at Citigroup Private Bank to become senior business development manager at Virtual Growth, a startup financial services software company.

“Great concept, wrong timing,” he said of the company. Soon after Foreman started, the tech bubble burst and he was laid off. But Foreman calls that year at Virtual Growth one of the most educational times in his professional career.

Watching the company fail to meet its business objectives and not secure financing helped shape how Foreman approaches investing today—particularly, making sure Tuatara’s portfolio companies have a strong enough corporate structure and balance sheet to move forward.

When the Great Recession hit in late 2007, Foreman was back in finance, this time as a managing director in
J.P. Morgan’s financial sponsors group. In the months preceding the downturn, economic forecasters detected signs of a credit crunch.

“Banks trying to syndicate leveraged loans were not able to find buyers on the other side. It was July 2007, and that was the first indication there was a credit crunch. That credit crunch was a year in advance of the actual recession setting in,” Foreman recalled.

2020 Applications

Foreman’s experience at J.P. Morgan still informs how he makes decisions today.

“Having had the opportunity to see how one of the premier banks in the world manages its overall portfolio … when dealing with challenging economic times” has served as a handbook for how Foreman is advising the companies in Tuatara’s portfolio.

Foreman estimated that most leaders at Tuatara’s portfolio companies have operated businesses or business units during recessions, but most haven’t experienced them as executives.

“This is going to be a challenging time for the cannabis industry because last year was its first credit crunch, and this year’s recession will be the first time the industry in a formal fashion has really had to navigate through a recessionary period,” he said.

Foreman also saw signs that yield curves would invert last summer, prompting Tuatara to take “a more bearish view” and expect a recession. With that knowledge, Foreman said he and his partners called meetings with portfolio and prospective pipeline companies to discuss their capital situations and time frames for hitting goals.

“Cash management is king,” Foreman said. “Make sure your working capital is well managed and the accounts receivables are in line. Track sales closely and sales momentum to understand if there is a material shift in sales, how that then will impact the rest of the organization.

“The timelines now need to be realistic in the context of the global economic markets and the challenges that they’re facing.”

 


 

Mark Iwanowski

Board member, Akerna, Denver

Mark Iwanowski, an IT veteran and serial entrepreneur who sits on the board of Denver-based regulatory compliance technology firm Akerna, and his companies seem to exit recessions stronger than when they entered them.

How?

  • Offering products with multiple uses.
  • Finding the most friction-free paths to revenue.
  • Having an eye for opportunities that yield big returns.

 

A Dual Strategy

Consider Applied Remote Technology, an underwater robotics company where Iwanowski served as executive vice president of business development when the 1990-91 recession hit. While fewer companies from the oil industry were buying the machines for underwater oil exploration, more revenue was coming in from the government and defense companies that used underwater robots for their own missions.

“The dual-use strategy was beneficial for a variety of reasons,” Iwanowski said. “On the defense side, there was increased spending compared to what was happening in the oil patch. So we adjusted our efforts.”

When Iwanowski makes business-development decisions, he considers the relationships between customer acquisition cost (CAC) and potential revenue per customer.

“In a recession, you have to look at that relationship very carefully,” he said. The CAC can go up while the long-term value goes down. “So you look where that friction is least and look to adjust to the markets.”

 

Deals for Tough Times

A few years later, Iwanowski was chief operating officer of the telecom and IT outsourcing business unit at Science Applications International Corp., which at the time was the largest privately held defense research firm in the country and primarily derived income from defense spending. But Iwanowski led SAIC’s foray into the commercial sector with deals that would provide the company capital to get through tough times later, including acquisitions of Bell Communications Research (Bellcore), the former research arm of the Baby Bell companies, and Network Solutions, the domain registrar. In the latter deal, SAIC paid about $12 million; about five years later, the company sold it for billions of dollars, Iwanowski recounted.

“Those were crazy times when we were literally inking deals … on the back of a napkin that turned out to be a $1 billion contract,” Iwanowski said, recounting a deal with Level 3 Communications, a telecom and IT services provider. “In a way, you knew it couldn’t sustain itself, but you were going to ride it.”

SAIC’s consulting business was also booming, but despite being flush with cash, they still refused businesses that offered to pay them in equity.

“We did not fall into that trap of accepting equity, because we knew whenever you have such a fast upside to the market, gravity ultimately takes over,” Iwanowski recalled. If companies failed, their equity payments would turn out to be worthless.

When the tech bubble burst and hurt SAIC’s commercial business, it was able to pivot back to and ramp up defense- industry revenue.

 

Hunker Down

When the subprime mortgage crisis hit, Iwanowski was managing partner at Trident Capital, an investment firm, and chair of one of the portfolio companies: software services firm KSR. Trident sensed credit tightening but went into defense mode after Sequoia Capital, with whom Iwanowski had worked, issued a now-famous 2008 report, “R.I.P. Good Times,” which forecast the economic downturn and instructed portfolio companies to cut costs and brace for the looming storm.

“Revenue and income are going to take a hit whenever you have that serious of a downturn. So you have to throttle everything back to align with the conditions to conserve cash. Because cash is absolutely king when you’re in those situations—whether it be to conserve capital, go acquire other players that are struggling maybe more to survive the downturn,” Iwanowski said.

 

Akerna Applications

Iwanowski believes Akerna is well positioned to weather the recession—in large part because it has a product that’s wanted by companies that compete against each other. He calls it the “Arms Dealer Model.”

“Instead of fighting the war where there’s a winner and a loser, you’re going to win no matter who wins the war,” Iwanowski said.

While cannabis companies such as Akerna need to hunker down, he also believes marijuana’s essential designation will improve legalization chances in many states and create opportunities for entrepreneurs.

 

NEXT: Broke Enough for Bankruptcy?