As anyone investing in technology knows, business is hard, technology is hard. Businesses that try to grow technology are therefore really hard. In fact, most of the investments that even experienced investors make will not return more than 1x the initial investment and could very well be nil returns.
In order to succeed in today’s competitive landscape a startup founder has to have a big dream and ambitious plans to get there. “Hustling” or “grinding” usually means getting it done when everyone else, including your friends and family, tell you that your idea is dumb or it could never work. Most of the time, ignoring feedback of this sort is a key personality trait for a successful founder however there is one simple rule that companies should not (but often do) ignore – YOU CAN’T SPEND MONEY YOU DON’T HAVE. You can’t also bank on network effects and word of mouth that you don’t have, but that’s for another post.
What does this mean in terms of your business plan?
- All the growth in the business plan can’t be based on phantom investment dollars that underpin lots of advertising
- You can’t have a business which progressively burns cash with no road to profitability that is based on raising more money to keep afloat
- You can’t justify a lack of growth / users / metrics / awareness for this year based on being in the middle of your capital raise
- You shouldn’t have an expectation that existing investors or friends and family will “bridge” you through a tough spot so that you can raise at a time when there are better metrics
These things seem self-evident, but unfortunately a lot of companies (even with well-meaning advisors) can get into trouble when the rubber hits the road, and what was previously a high-flying business in Month 3 with 6 months runway becomes a distressed business in Month 6 looking at declining prospects with declining runway. I was reading a book on marketing the other day which explains the compounding effect. Research shows that not only do the leading companies in a segment have an absolute edge (not surprising) over other companies in terms of market share and power but the impact on those smaller firms is significantly worse even on a relative basis when something happens (also not surprising).
Think of it this way, if your company is raising $1.2m on revenue of $3m and you are burning $800k a year (18 months runway) and you happen to hit $2m revenue instead – not only are you now burning a run rate $1.8m per year, assuming nothing else changes, but your runway is now shorter than 1 year even assuming the full raise. Meanwhile your chance of raising $1.2m also decreases because people will question a forecast which shows a 33% miss to the LTM financials.
Usually at this point one of two things happens:
- Either the company can only raise say a partial amount e.g 600k, and it raises that (which might be as little as 3 months money)
- There is an offer for $1.2m but at 50% less than the proposed valuation which the company then rejects and then asks existing shareholders for a bridge and hopes that they can raise in 3 months more time assuming that the revenue is nearer to a run rate of $3m
What went wrong here? The company’s plan was based on spending money it didn’t have and needed to raise as new capital. When sales didn’t materialise, it didn’t cut costs or re-evaluate its strategy it just tried to keep pushing through or “hustling”. This sometimes works, but unless your name is Elon or Jobs, it’s a high-risk strategy.
What could they have done instead? Y Combinator founder Paul Graham has a great article about are you “default dead” or “default alive”. Basically, is the default state of your company burning through all your cash unless you raise more or is there some path to profitability and a self-sustaining business. It is surprising how many companies don’t know the answer to this question and that the answer can’t be “default alive, assuming we raise this next round”. After all, you can’t control anything about your business, you can’t control your customers, or the market, or technology trends or growth. You can and should however be 100% responsible that you don’t run out of money. Putting aside the legal and directors’ duties involved, you are spending 110% of your waking hours building something great – why put it all at risk?
What else can you do to work out if your business is moving in the right direction? My last post talked about re-reading Geoffrey Moore’s Crossing the Chasm*. Chapter 4 talks about knowing your market. As an investor we are looking for great entrepreneurs that can specifically and firmly state what is their ‘target beachhead”. This means a) not pursuing every market at once to make a sale b) firmly describing what is core and non-core c) growing your presence, reputation and market and though leadership organically and by direct sales / face time to be the dominant player in your niche of the world (no matter how small). Doing this is a great mitigant to spending hundreds of thousands of dollars on “general” advertising and brandbuilding or building products and features you don’t need – which can be two of the largest costs at seed / early stage.
Chapter 6 talks about refining your market positioning message. An extension of the previous idea is you should be able to simply and effectively describe who you are, how you fit in with the other products and what you are for, and what they are for. If you don’t know the answers to all these questions, you can keep costs to a minimum until the time when you do or have a very good idea of what they are. Again if your name is Bezos you can try the “if you build it they will come” approach but it is a good idea to get out there, start interviewing your customers, your investors and your peers and making sure that your product addresses a big enough need – I’ve heard of companies that don’t do more than 24 hours of product development without testing it on a live and super passionate client. If you don’t know the answers to these questions, you can also be super critical / transparent about the effectiveness or non-effectiveness of cost base in the organisation.
In short, if you are in the middle of re-evaluating your 2018 business plan at the start of this year, I encourage you to really focus on what you can do with the cash you have in the bank today. Further capital is an accelerant of great business models, not a fixer of bad ones. You may sail pretty close to the wind cash wise (see AirBnB and the famous Obama cereal) but if you maintain cost control, focus and a (financial) mindset which is focused on not going out of business than you can take the next steps to building a product mindset which is ready to grow your startup.
*Anyway, again, if you are a SaaS or enterprise sales product, I highly recommend you read the entire book. If you aren’t, I still recommend you do – although some of the principles won’t be totally applicable.