Gather round and listen to an untold story that is happening right now all over startup land. I can’t name names but have seen it play out in two acts.
Act I. A company has one positive press release after another, announcing successive rounds of fundraising, new customers, impressive hires.
Act II. The company suddenly shuts its doors or is acqui-hired. How could something so seemingly hot end so suddenly and tragically?
Our story begins the day after a company has finally closed its $8 million B round. The CEO followed the lean startup playbook, established enough product market fit to get some customers, and raised an expansion round. As company management gazes at a seemingly-endless 18 months of cash runway, excitement abounds throughout the company. Hiring and spending for growth begin in earnest. Salaries are bumped up to “market” rates. Cars get purchased. Sighs of relief from startup spouses are audible for miles. These are heady times indeed.
Fast-forward 85 days, just prior to the 3rd post-funding board meeting. Revenue has fallen well behind plan, and expenses have grown just as planned. Which means that monthly cash burn is scary, and what should be 15 months of remaining runway looks more like 9 to 12 months. The CEO, with fingers crossed, calls each board member ahead of the next day’s board meeting to presell a financing idea.
“Revenue is behind plan a few months. I am not happy about it, but we are ramping our new sales folks, so the sales cycle is a bit longer than we saw last year. But they will soon hit their stride – the pipeline is solid. We need to keep our foot on the accelerator here. It’s not ideal, but I can restore our lost runway with a few million in venture debt. I have a term sheet in hand I would like to approve at the meeting tomorrow.”
Warning lights flash and sirens blare when I hear these words. The company raised an expansion round, based on what we all hoped was scalable product market fit. Now the market is telling us that fit isn’t right yet, but management has chosen not to listen.
How will this story end? That depends on the willingness of the board and the team to swallow medicine.
The right strategy at this juncture is to preserve those B round dollars. Reduce burn back to pre B-round levels. Iterate on the product; buy sufficient time to get it right with minimal inside equity and above all no debt. Raising venture debt is a reasonable way to fund working capital in times of high growth, not to extend runway in uncertain situations, as seductive as that might seem.
To management, retrenching so soon after that affirming B round is alarmist, extreme and out of the question. They are not eager to admit fault of course, but also worry that reducing burn, which involves lay-offs, will impact the company morale that management has nurtured since day 1.
Increasing risk with debt and high burn is far preferable to such a public display of distress. The B round investor is angry, but not ready to admit a mistake. Yet the board feels compelled to act. I often see one or both of the following. If the founder is still the CEO, then the board will hire a “growth stage” CEO. Or, everyone’s favorite scapegoat, the VP of sales, gets replaced, which amounts to shooting the messenger. Six months later, with most of the B round spent, the company finds itself on life support. The “canary in the coal mine” is when the company’s best developer gets hired away.
All too rare is the courageous CEO that makes a call like this:
“Revenue is behind and I need you at an emergency all-day offsite on Saturday. I want more cushion — I am thinking I can get 6 extra months of runway without raising capital with some decisive action now. The executive team has taken a salary reduction, we have a RIF proposal to go over with you, we have cut $50,000 per month out of T&E and marketing spend that isn’t paying off, and we think we can grow margin with some product pricing adjustments. But top line growth is going to slow down until we better figure out product/market fit here.”
The irony of burn-reduction avoidance is that so many successful companies look back on gut-wrenching burn reduction as the smartest, toughest thing they ever did. They are amazed at how efficient they got, how the culture survived, and how much was accomplished with so little.
My main point here is that burning high is the easy way out for everyone, until it isn’t. Managing burn is the most important function of a company and its Board. It is an art form learned over decades of practice. Be the management team that is secure enough to admit when it is time to retrench, and seasoned enough to see it early. Then your board will be eager to roll up sleeves and fix the problems alongside you, not in conflict with you when you are about to hit the wall after false promises.
[Image via myITforum]