Or, How Not to Drive Your Company Off A Cliff
Many startups very recently went from “working” to “not working.” Revenue growth went from fast and “hitting plan” to linear at best and shrinking at worst.
The unsaid industry suspicion is that a lot of these companies, even the heavily funded ones, are the walking dead. Given the funding environment of the past few years, many stalled companies still have $5M, $10M, even $100M+ of venture funding in the bank. This is objectively a lot of money. But even with all this money in the bank, if companies maintain high burn without improved growth (or to speak more plainly, continue to lose a lot of money every month) they will die. It is quite possible to vaporize $100M. If you have 300 people but $25M of 80% gross margin revenue, you will do it in approximately eighteen months.
It could take some time for the heavily funded companies to feel the pressure, but when they die, they will destroy more capital than venture-backed startups did ten years ago. Raising a large amount of money before building a viable business does not insure against startup death. It is certain that multiple high-flying startups that have raised $100M or more will shutter in the next few years, either because they were never real companies and just phantasms of 2021 euphoria, or because they refused to accept the new reality quickly enough.
How can you avoid this? Step one is to avoid poisonous delusions that founders are prone to in this stalled and default-dead period. One common delusion is believing they can raise more money from investors and thus avoid other seemingly impossible paths (get profitable, grow fast).
One of the reasons for this fundraising delusion is that their company is bigger and has made some progress relative to the last time they raised money. They have added impressive hires, users and revenue. Unfortunately, the more money a company raises, the higher the bar is raised. Venture capitalists can only see forward, like a predator without peripheral vision. They are not evaluating your progress from 0 to 20,000 users or from $3M to $10M of ARR – they are evaluating your momentum, your burn, and your long-term potential going forward. If the company looks like it has stalled, but has high burn, your chances of raising capital before reacceleration are essentially zero. Your classification has changed from “too early to tell” to “not working” and unlikely to become an important public company.
Another reason for this fundraising delusion is that investors get more financially oriented as a company matures. Initial rounds are often done by friends, operators and angel investors. Early-stage venture investors are still people and product-oriented, and they love to dream with the founders, but they are less forgiving and more demanding. Growth investors care about all that, but also about your numbers and whether you’re a category winner. Crossover investors care about the quality of your long-term business model. Public markets investors care about whether you made your quarter. Sally Angel Investor loves you and your vision, but Joe Hedge Fund Guy simply sees a set of financial statements. He does not care about your vision or your product. You are dealing with different people.
The third reason for this fundraising delusion is that founders expect investors to take the macro into account. They point out that everything is harder in ways that are not the fault of their own execution: consumer spending is down, customers are freezing budgets and literally shrinking in addressable seats, their public competitors also missed earnings targets. Investors are aware of this, but they do not care. They are experiencing pain across their portfolios and they are underwater on other investments, which makes them fearful. They are also aware of a very small number of startups that are growing nicely despite the macro, and those are the only companies that every investor wants in on.
The other common delusion founders suffer from is that their company is already running “as lean as it can.” There are almost no lean companies founded in the past seven years. This is not a value judgment, but a consequence of the fundraising environment. Investors enabled this: cheap dollars create bad habits. If it is easier to hire more people than deal with low performers, then that’s what will happen. If it is easier to have a culture of low work ethic, that’s what will happen. If it is easier to throw bodies against a problem than to automate it, that’s what will happen. If it feels like you can always return to a job at Google, then people without the appropriate risk tolerance will try working at startups.
The root of this “as lean as we can be” delusion is fear. Starting a company means taking responsibility for other people, and founders naturally want to avoid the pain of letting those people down. They fear losing face with their friends, customers and employees if they do a deep RIF. For companies whose identity is “winning” and continually-bigger valuations, and whose employees expect guaranteed cash and short-term wealth, it is a rough adjustment. For founders who are always selling – to customers, to the board, to recruits, to investors, it is a rough adjustment. They are worried about discovering that the people they’ve hired will lose faith in them, are mercenaries and only there for the easy times, or cannot and will not work smarter or harder. They are worried that many of them are really big-company people. Of course, there is a kernel of truth in this fear – some employees will seek greener pastures.
The other cause of this delusion is the extreme nature of the current problem. There was no backpressure in the system, and so companies overhired in an extreme way. Resolving this will take measures which have recently not been in the Overton window of tech culture. It is highly unlikely that a 10% headcount cut is the solution to a startup's problems. It is possible that a 30% or 75% headcount cut is. Paradoxically, it seems inconceivable, even offensive to consider a cut that deep while it is still useful. You must fight this dynamic. There are plenty of companies out there that have built 15-person sales teams before a single rep is productively ramped, or 50-person R&D teams before it is clear that users want the product. Cutting the entire sales team until you have confidence in the playbook and have a full opportunity pipeline, or 75% of the R&D team if you don’t have strong product-market fit, is very possibly the right solution, but it’s an ugly one that requires accepting sunk costs for what they are. Keeping those people employed when the company isn’t on a path to success only delays the pain and wastes their time. They may not even be the right people if you change your product or go-to-market dramatically.
What do you do if you’re in this likely fatal, but increasingly common situation?
One option is to shut down and return remaining money to investors. If the core thesis was wrong, or the strategic tide feels like it has turned irreversibly against you, this can be the rational path in saving time and money. However, rarely is this the only path. This often boils down to the team giving up, and just not having the energy or desire to keep going.
If there is already value creation (a product people want, a customer / revenue base) another option is to sell the company. In this case, it is useful to understand that acquirers universally do not like to buy companies with high burn. If they are a startup, they are worried about their burn. If they are a public company, they are worried about impact to earnings. If they are a private equity firm, they are worried about profitability. Founders often want to delay a cut and have the acquirer decide who to cut, but this avoidance will make you unattractive.
The final option is to do a hard reset that accomplishes three things:
- buys the company enough time
- sets goals that change the company’s outcome
- focuses the team with a plan
Buying a company enough time is a worthy cause as a founder. Lower burn and longer runway gives a team additional shots on goal in product. Building things and getting adoption takes time. SpaceX would have died if Elon hadn’t figured out how to fund it through their first successful launch and subsequent first NASA contract (six years and three failed launches after the company’s founding). Buying enough time can let a market mature and catch up to a team that bet a little too far ahead.
It is essential to be honest about what goals change a company’s outcomes. A sub-scale software company growing 25% a year and not re-accelerating is not fundable by a high-quality venture firm. If you are an early-stage company that has suddenly decelerated to 25% a year and you don’t know how to drive 70% growth, it can be tempting to set a goal of 40%. But that goal does not change the company outcome. The 40% grower also doesn't get funded. If you are burning $1M/month, and you know in your heart of hearts you won’t be able to fundraise before you run out of money, it can be tempting to set a goal of cutting burn to $500K/month. But that goal will not change your outcome, because you will still run out of money. Choose a goal that does change your outcome, even if it feels impossible, and take focused shots on that goal. Anything else is admitting defeat.
Half of focusing the team with a plan is clarity on the company’s situation. If you are in wartime, say so. If you have hired good people, they are smart. They see the environment, they see the truth on the ground, and transparency breeds trust. There is no way to assure them except with the truth. RIFs, temporary revenue deceleration and down rounds are all recoverable, secondary events. The only first order issues are whether you have a long term business and whether you can survive long enough to get there.
Several things actually become better with less easy money. A tough macro thins the field, and reduces irrational spending behavior from competitors. A tough macro changes the talent landscape. For the first time in a decade, many tech employees are grateful to have a job, rather than always looking over their shoulder for a better opportunity. Meta doesn’t want them anymore. A company crisis like a RIF is a sorting hat for drivers, who solve problems and take ownership, and passengers, who expect other people to. It is easier to try new things with 10 people than with 50. When the company is not working, you want maximum degrees of freedom for change, because you likely need to make dramatic changes.
Lowered interim valuations do not have to lead to death. Clearly, some legendary companies survived the dotcom bubble to thrive another day. In the example of Amazon, they saw their share price dive ~95%, and then proceed to compound for two decades. However, as explained above, wishful thinking around fundraising (and contortions to avoid “down rounds”) can lead to death.
It is an unpopular view, but startups are not for everyone. Startups are not for people who panic in times of crisis, they are not for people who want to work 9-to-5, and they are not for people who seek financial stability or a cash salary competitive with FAANG. They are not for people who are going to be offended that someone is sleeping at the office. Teams will once again be more appropriately, and more sparsely populated.
Almost every founder is now navigating rough waters. Given what Jerome Powell continues to gesture about interest rates, it is likely to get worse before it gets better. If your company is underperforming, you can continue on in denial and misery and drive off the cliff, or you can choose intellectual honesty, vanquish useless delusions, and do a hard reset. It is deeply painful from a human perspective, and organizations are fragile things, but people rise to amazing challenges in startups, and driving the car off the cliff eventually does none of your employees any good. Regardless of the macro, the opportunity remains more real than ever - technology comes in cycles, but is secular. Creativity is ever-present. Venture capital round sizes are 3-10X larger than they were in 2010, and companies have more room to operate than they think.
Don’t squander that cash. Get through the fourth launch.