Macabre as it may be, startups need to plan just as well.
This note is meant to help those founders who have recently closed a round of funding think through their companys untimely demise.
Recognize Your Mortality
Founders are optimists by nature, and we have all surely daydreamed about what our business looks like if things go right. Magazine covers. 3 Commas. The good stuff.
Well-conditioned entrepreneurs pay lip service to downside risks and say the right things following a financing. Theyll say, Funding isnt a milestone to celebrate, and We enjoy tonight, but back to business as usual tomorrow, but very few founders have thought about the risks in a constructive, actionable way.
Analyze Your Startup Like An Actuary
My first word of warning is to be analytical about your startup. Know the revenue numbers for your closest competitors. Read every market report and trade journal you can find. Beware starts with Be Aware. Attend trade shows. Assemble a list of the M&A transactions that have happened in the last few years and benchmark yourself against them.
You need to develop a sixth sense for how the market works, who the players are and what motivates them. The difference between a billion-dollar exit, an acqui-hire and bankruptcy can sometimes come down to your peripheral awareness. Who scares you? Who do you scare?
Cultivate Awareness: Read the 10K filings of your closest competitors. Check in on Linkedin to see who theyre hiring. Keep your eye on your shop first, but obsess about your market.Figure Out Who Would Buy You, Ahead Of Time: As soon as you raise money, youre on the clock. You should be reaching out to the companies that would conceivably buy you. These are lifelines. Theyre also sources of advice and information along the way. The goal isnt to sell before youve even get started, but to have warm relationships with the right decision makers if things dont work out as planned.Measure Your Life Expectancy
You need to know how much time your company has left, and plan accordingly.
The first thing to consider is if your business is an all or nothing proposition. Aero was a great example of this. The founder explicitly told his investors that his company would be their biggest deal or a complete write-off. Knowledge like this can be liberating. You leave everything on the field. If youre on this trajectory, burn the candle at both ends and sprint toward success or failure.
Well-conditioned entrepreneurs pay lip service to downside risks.
Assuming youre not playing the go big or go home game, you should develop a framework to think about how to grow your business. Should you increase your burn rate to get a new product out? Is there enough traction (and internal bandwidth) to double down on acquisition spend? Or do you stay the course and lengthen your runway?
You need to carefully balance the operational benefits of each with the impact theyll have on your fundraising and exit options. Chasing a billion-dollar exit is exciting, but most founders, andVC funds, would settle for less.
Financing helps clarify this. With every dollar of venture capital you take youre also implicitly committing to a sale of your company at ~10X the post (especially in your seed to Series C rounds). That calculus should help inform your strategic decision making process.
Discuss Exit Options With Advisors At Key Moments: Find a group of trusted advisors who will check your logic with regard to major strategic decisions, like fundraising.CreateA List Of Possible Acquirers: Understand their cash positions, what their history of M&A activity looks like and use that as a rubric for processing strategic decisions that would close off other options.Learn How To RunA Zombie Company
Managing success isnt easy, but its a high-class problem. Likewise, when things go pear-shaped, there is a well-established playbook, from legal frameworks to handle bankruptcy, to a set of norms about dealing with employees and investors. The biggest challenge a startup leader will face is when the business is plodding along slowly, like a zombie. What makes this dreaded middle so frustrating is that it looks positive.
In the (admittedly sometimes abnormal) world of VC-funded startups, failure could even be described as 2 percent month-on-month growth. Any small business growing at this rate would be thrilled, but a VC-funded company growing at that rate risks no external follow-on round.
Some VCs will start to disengage when they think youre stuck in the dreaded middle. Others will continue to help, but youll notice emails take a few days longer to get returned. This problem is exacerbated by the trend toward party rounds. Youll find that when the buzz at the party dies down, fewer folks stick around to help clean up.
Capital is a magical tool that allows you to play by different rules.
This seems counterintuitive.Why wouldnt investors spend more time with a company thats showing potential and on the brink of profitability? For VCs, its a matter of opportunity cost. The founders still need advice and support, but the prospect of it turning into a 10X company is so much more remote. As tough as this may sound, companies that fail outright are better for some VCs, in that they allow the investors to double down their time on companies that will enjoy outsize gains.
The best way to manage the middle is to own your destiny.
If youre growing, even slowly, it suggests that the business has potential. Fight to protect it. Ive seen startups in the middle break out. Sometimes founders just need to stick to their knitting, focus on growth and the market catches up with them. For those who are disheartened, dont give up hope. Pandora and Apple both survived darker periods by culling and focusing on their best assets to come back roaring.
Make Cuts, Quickly And Cleanly: This is a painful process. It often means laying off 60 percent of your workforce, even the people who outperformed against the tasks you gave them. If youve got a high profile, you can expect critical tech journalists to second-guess your skills.Prepare ForA Post-Capital World: These challenges are difficult, but even harder is weaning yourself off the dream fuel of capital. Capital is a magical tool that allows you to play by different rules. Once you realize youre in the middle, italso can vanish and leave you with the everyday realities of a small business.Figure Out Your Next Step: Do a real gut check and ask how committed you are to the business. Do you want to grind out the company at a subsistence level for another 5-10 years? Is there a Hail Mary product plan? Or do you just need some time to close a sale to an acquirer? Try to pull your options together and review them with the board.MakeA Clear-Eyed Assessment
When you realize youre in the dreaded middle,take an inventory of the situation and ask yourself a few key questions:
Do You Understand Why The Business Isnt Working?
The context is not ready for you: Sometimes youre just too early. And as many people will tell you, thats as bad as being too late or wrong. Id argue that its not as bad. If your major problem is that the theory and reality have not yet merged, you can hunker down and try to wait.
Youre not the right person to lead it: Not everyone who starts a company has the right skills to scale it. With enough cash, supportive investors and enthusiasm for the market, it might be time to hire a pro CEO. Even if, eventually, you make up your mind to go with this, dont underestimate how hard it is to graft on the right person.
You were beaten by a competitor: Some startup sectors get hot and a winner runs away with the market. Youre blocked out by network effects. Your competitor captured the zeitgeist, or is just flatly out-executing. Think Uber and Lyft. In this case, its wise to think of an opportunity to pivot; a strategic sale, or perhaps a merger.
Are You Committed To The Business?
Have you raised a lot of money? How long have you been at it? Whats your relationship with your investors and team?
These questions are hard to answer. You want to protect your relationships with the people who bet on your leadership. If you plan on staying in the startup community, this is critical.
But on the other hand, if youre smart and skilled enough to raise VC money, theres an opportunity cost to sticking with a business that has limited options.
This is why the advice is that you should pursue startups you want to see in the world, regardless of the outsized financial wins, because you might be stuck with it for quite some time.
Are You BuildingA Business Or An Asset?
A business has no value without you and your team, but an asset can be sold to a larger company. If you have built a business, its likely too late to make a major pivot, but if a few development cycles could productize some aspect of your business thats currently manual, you might want to think about prioritizing them.
Look for the embedded call options in your business and do everything you can to keep those options alive.
Work with your investors. Once youve worked out your motivations, be direct with your investors. What resources do you need to get to a point of sustainable profitability? Youre not going to do a Series D based on middling metrics, but what kind of support could lead to a better outcome for all involved?
Managing Employee Expectations DuringA Downturn
Anyone who is half-awake, and half-good, will be looking for greener pastures when your company starts to struggle. The reality is that youre really competing against every other VC-funded company, regardless of market. In an efficient market, employees manage themselves and the best are constantly chasing growth.
I remember having dinner with a portfolio founder the day Instagram sold to Facebook. The tech press was jubilant, but the CEO was in despair. He told me, Im going to lose two more engineers this week. His team sussed out that the company wasnt going to be the next Instagram and looked for a company that still had that potential.
Your best employees will be the first to leave.
The best startup employees want to be part of a rocket ship, not a jetliner. Whats crazy is that the company he started was successful! It ended up enjoying a meaningful acquisition a few years later. Still, that wasnt enough to keep his core team together in the face of more enticing options.
Your best employees will be the first to leave.
Employees who sign up for the startup life might not be the ones best suited for a small business mindset. Theyre focused on speed of execution, not minimizing expense. They might have taken a salary cut with the hopes that stock options would make them wealthy. Its also likely that they were star performers that add immeasurable value to your culture.
Hire Missionaries First: Many people criticize mercenaries, hired-gun experts who dont care about your product but many brilliant businesses have been built on their backs. And mercenaries are amazing when times are good. As talented as they are, they shouldnt be your first hires. Try to build out your core team with true believers and add the hired guns when the good times allow.Never Stop Selling Internally: Dont stop selling people on the company after theyve joined. Make storytelling a part of your skill set and the companys culture. In good times, share encouraging news: It helps to lay the groundwork for (some) loyalty when times get tougher.The Merit Of The Hail Mary
When stuck in the middle, many founders start to think about Hail Mary approaches.
Sometimes these work out brilliantly. When AOL merged with Time Warner, it was seen as a huge risk, but in hindsight was clearly a stroke of genius. An overvalued asset leveraged unsustainable paper value to buy huge tangible revenues. This strategy only really works if youve still got a sense of momentum, but you can tell your business isnt really going to pay off.
Startups Dying IsA Feature, NotA Bug, Of Venture Capital
Many startups are going to die. Even decent prospects approaching profitability will be on the chopping block. Some look at this viewpoint as a failing of the VC industry, or at least a source of confusion.
While there is clearly an entirely different part of the private equity market that thrives by letting businesses throw off cash, venture capital is completely different: Its rocket fuel, not 87-octane regular gasoline. You need to ride hard or die.
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