David Frankel
Having children is one of the happiest moments most people will ever enjoy, but it’s also when you need to first think the most seriously about death. The joyous excitement and freneticism (baby names! equipment!) that surround birth is paired with the grim reality of life insurance policies and the act of considering the finite valuation of your remaining days. It’s not fun, but it’s the responsible thing parents need to do to protect the people who depend on them.
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 company’s 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. They’ll say, “Funding isn’t 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?
Actionable Steps:
- Cultivate Awareness: Read the 10K filings of your closest competitors. Check in on Linkedin to see who they’re 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, you’re on the clock. You should be reaching out to the companies that would conceivably buy you. These are lifelines. They’re also sources of advice and information along the way. The goal isn’t to sell before you’ve even get started, but to have warm relationships with the right decision makers if things don’t 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 you’re on this trajectory, burn the candle at both ends and sprint toward success or failure.
Assuming you’re 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 they’ll have on your fundraising and exit options. Chasing a billion-dollar exit is exciting, but most founders, and VC funds, would settle for less.
Financing helps clarify this. With every dollar of venture capital you take you’re 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.
Actionable Steps:
- 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.
- Create A 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 Run A “Zombie” Company
Managing success isn’t easy, but it’s 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 you’re stuck in the dreaded middle. Others will continue to help, but you’ll notice emails take a few days longer to get returned. This problem is exacerbated by the trend toward “party rounds.” You’ll find that when the buzz at the party dies down, fewer folks stick around to help clean up.
This seems counterintuitive. Why wouldn’t investors spend more time with a company that’s showing potential and on the brink of profitability? For VCs, it’s 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 you’re growing, even slowly, it suggests that the business has potential. Fight to protect it. I’ve 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, don’t give up hope. Pandora and Apple both survived darker periods by culling and focusing on their best assets to come back roaring.
Actionable Steps:
- 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 you’ve got a high profile, you can expect critical tech journalists to second-guess your skills.
- Prepare For A 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 you’re in the middle, it also 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.
Make A Clear-Eyed Assessment
When you realize you’re in the dreaded middle, take an inventory of the situation and ask yourself a few key questions:
Do You Understand Why The Business Isn’t Working?
The context is not ready for you: Sometimes you’re just too early. And as many people will tell you, that’s as bad as being too late or wrong. I’d argue that it’s 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.
You’re 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, don’t 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. You’re blocked out by network effects. Your competitor captured the zeitgeist, or is just flatly out-executing. Think Uber and Lyft. In this case, it’s 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? What’s 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 you’re smart and skilled enough to raise VC money, there’s 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 Building A 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, it’s likely too late to make a major pivot, but if a few development cycles could productize some aspect of your business that’s 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 you’ve worked out your motivations, be direct with your investors. What resources do you need to get to a point of sustainable profitability? You’re 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 During A 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 you’re 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, “I’m going to lose two more engineers this week.” His team sussed out that the company wasn’t going to be the next Instagram and looked for a company that still had that potential.
The best startup employees want to be part of a rocket ship, not a jetliner. What’s crazy is that the company he started was successful! It ended up enjoying a meaningful acquisition a few years later. Still, that wasn’t 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. They’re 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. It’s also likely that they were star performers that add immeasurable value to your culture.
Actionable Steps:
- Hire Missionaries First: Many people criticize mercenaries, hired-gun experts who don’t 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 shouldn’t 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: Don’t stop selling people on the company after they’ve joined. Make storytelling a part of your skill set and the company’s 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 you’ve still got a sense of momentum, but you can tell your business isn’t really going to pay off.
Startups Dying Is A Feature, Not A 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: It’s rocket fuel, not 87-octane regular gasoline. You need to ride hard or die.
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