When the world turns upside down, startups find themselves on shaky ground. It's like navigating a treacherous mountain pass with no map, no guide, and no sense of direction.
The journey may require a complete overhaul of their operational plan, the painful process of cutting jobs and looking for fundraising opportunities. But startups must face the reality of their situation and take bold action to survive — at least that’s what many VCs keep telling founders around the globe.
Two options to move ahead
In times of crisis, startups should make sure they become either “default alive” or “default investable” as soon as possible, according to Christoph Janz, managing partner of Point Nine Capital.
The default alive mode means companies can survive without raising additional funds. If founders of money-losing companies can’t or don't want to cut costs to break even, they must make sure their metrics are good enough to make VCs want to invest in them.
When deciding to invest, VCs look at different factors — there’s never a simple formula. But Janz believes founders looking to become default investable should keep in mind these three metrics: growth rate, burn multiple, and sales efficiency.
At the same time, legendary Sequoia Capital — in a memo published by The Information — notes that, currently, investors’ focus is shifting to companies with profitability.
“With the cost of capital rising (both debt and equity), the market is signaling a strong preference for companies who can generate cash today,” the firm writes. “Unlike prior periods, sources of cheap capital are not coming to save the day.”
Tracking path to default alive
To weather the global crisis, startups should consider cutting back marketing expenses, PR and SaaS spending, as well as random incidental spending on perks and parties. In some cases, however, letting people go is the only available option to save money, as payroll costs are the most likely source of a high burn scenario.
If cutting jobs is necessary, it's best to make deeper cuts and lay off more aggressively rather than doing it incrementally, according to Bob Sutton, a professor of organizational behavior at Stanford University. Although a single deep cut is hell, it is a better alternative than wave after wave of smaller cuts, he says.
“One of the worst things a boss or company can do is to make constant cuts at seemingly random intervals, as it causes people to live in a constant state of fear as they wait for the other shoe to fall,” Sutton says.
Dragging things out is an especially bad strategy if a startup has less than three months of cash, according to Y Combinator. “If you are in this state, it is immediately necessary to lay off your employees and give them severance, pay down your obligations, and use your remaining cash for shutdown costs,” writes Y Combinator in its address to founders.
“If you don't do this and instead end up with zero cash and outstanding payroll, tax or other obligations, things will get very bad,” the address reads.
At the same time, Mike Volpi, partner at Index Ventures, believes that, before blindly cutting spending, it’s important to be strategic and deliberate.
“Today’s environment requires subtle and precise control and management of the business,” Volpi writes in a letter published by TechCrunch. “The first step in navigating through stormy waters is to make a cold, hard assessment of your business.”
Then, Volpi says, founders can decide on the next steps: Staying aggressive if they have 2+ years of runway, or if it’s less, prioritizing ruthlessly.
In any case, founders should make sure to communicate plans with the employees so they understand that each action is deliberate. “Even if things go poorly, behave in a way you would be proud of,” writes YC.
If there’s no way to either break even or raise more money, founders can seek an exit. “When you can’t quite make it to product-market fit, there’s a third choice that too many entrepreneurs, and their investors, overlook: selling out,” says Kittu Kolluri, founder and managing director of Neotribe Ventures.
According to Kolluri, founders often feel they have to become a unicorn, but in reality, sometimes playing the short game delivers more value to founders, investors, employees and the acquiring company than the long game ever could.