As recent market declines curtail the value of global tech giants like Shopify and Netflix, effects are trickling down to the early-stage startup universe. After a decade of thriving valuations and flushed capital, companies and investors are preparing for the worst to come. Founders are reaching out for advice on fundraising, spending, hiring, and growing in times of uncertainty.
My take is to always begin by understanding how much cash and runway you have, and whether that makes the company default alive or default dead.
Paul Graham, essentially, defines ‘default alive’ as a term that refers to a company that is profitable enough to exist indefinitely without investor funding. If you are not ‘default alive’, you risk being ‘default dead’ – which puts you entirely at the mercy of the next funding round. There is no middle ground. If you are ‘default dead’, the only way out to ‘default alive’ is to either grow revenue faster, cut costs, or both.
It is not an easy thought to entertain though. Personally, it took a rude awakening to reset in the right direction. An investor, who had backed us for nearly two decades, sent in his final check one day and declared, “This is the last support you are getting from me. If you cannot be profitable by then, just liquidate.” We had to change our mindset and methods to operate from a place of scarcity. Things eventually turned around. We went from the cliff of liquidation to breaking even in a year and becoming cash flow positive in the month after – and this was how we did it.
1. Data: You cannot work on what you do not know
Accurate metric tracking systems are often beyond a startup’s budget but having a realistic grasp on reasonably complete and timely figures gives you control over the situation. Data quality and cost is a delicate balance. Start by focusing on the vital metrics that matter most – the ones that affect your net cash flow and runway. For most companies, that means revenue, expenses, growth rate and bank balances. Non-financial metrics are crucial in providing more context for financial metrics. For a B2B business, that means knowing the credit terms and sales cycle and how it affects your cash flow cycle. For a D2C or B2C business, it’s pertinent to know your customer acquisition cost, lifetime value and how it affects your R+K. (I strongly suggest delving into R+K here).
We started with sporadic management reports across departments with reliable data taking days or even weeks to consolidate. Our first order of business was to set in place real-time and integrated data tracking systems that monitored status quo and analyzed the impact of any changes implemented. Over time, this fostered a data-centric culture that ensured we were reacting to the right signals, while teasing out any underlying issues and opportunities in the business. As a bonus, we also uncovered varying degrees of fraud and embezzlement happening right under our noses – something that we cracked down on immediately.
2. Prioritization: Run a tight ship and stick to the bare necessities
Many founders come to the confounding conclusion that you need to spend money to make money. The reality is that all expenditures – hiring brilliant folks, developing exciting new features – no matter how justified they sound, will eventually truncate your runway.
With the goal of becoming self-sustaining as soon as possible, I began my thought process with a blank sheet – essentially reflecting retrospectively on what would have been the best way to operate the business with our current resources. We reevaluated and redesigned our strategies on manufacturing, go-to-market and product, which were identified as having the biggest impact on our cash flow.
- On go-to-market, we retained only the most cost-effective customer acquisition strategies, fired B2B customers with poor credit histories, doubled down on channels/platforms with the highest ROI and adjusted our pricing across geographies, channels and products for profit maximization.
- Product portfolios were streamlined according to top volume and contribution (defined here as revenue - cost of sales - marketing cost - direct labor). We cut out non-priority features that increased marginal cost to customers but maintained our main value proposition.
- Shuttered non-core and underperforming business units and outsourced them to lower-cost markets. This afforded some breathing room and allowed us to deploy capital to other core business operations.
Sacrifices were made, some more painful than others. In the year after, a massively improved cash flow more than made up for the slight drop in revenue, and profitability surged. From there, we were free from the fear of running out of cash and were able to grow at our own pace.
3. People - transparency is the best policy.
The most disruptive changes in the process of cost-cutting are often restructuring and the layoffs that come with it. Putting people on the chopping block - no matter how necessary for the business - is stressful not only for those being let go, but also the ones staying. Often, cost savings are overshadowed by bad publicity, plummeting morale, higher voluntary turnover and lower productivity – which hurt profits in the long run. And that is why it is so important to handle retrenchment processes thoughtfully in a way that feels fair for everyone involved.
In the company’s hardest times, we decided to scale down from about a hundred employees to a single digit. It was one of the hardest decisions without a doubt. We took stock of the existing workforce. We phased out half of the team along with non-core and underperforming business units. For the half that remained, I divided them into two camps: maintenance and production staff.
- Maintenance: those needed to maintain the company’s daily operations and status quo.
- Production: the creators and growth drivers of the business.
Further cuts were made on those who did not contribute quantifiably to the short term survivability of the business – which included excess maintenance staff and production staff that could easily be rehired.
We initially made the mistake of firing discreetly – which only fueled unfounded rumors, panic and, very nearly, a worker strike. Trust had to be rebuilt with candor and honesty from the top. We held town halls conveying why retrenchments were planned, and what that meant for employees and the company. When the process ended, we strengthened morale with team bonding sessions that reiterated the firm’s vision and incentivized remaining staff.
A final note
It is never too early to ask the sobering question of whether you are ‘default alive’ or ‘default dead’. In fact, all startups start out default dead. But the great ones keep optimizing, pivoting and growing into real products that eventually deliver customer value and become commercially successful – before money runs out. The process will always involve painful, not so glamorous, but necessary decisions. That is the coming-of-age of every successful startup.