Gaetano Crupi
Over the past few months, investors from Sequoia to YC have sounded the clarion call to get their portfolio companies preparing for winter. At this stage, it does not matter if we agree or not: Enough momentum in the market has shifted that market behavior has become a self-fulfilling reality.
Over the past 60 days, we have been working closely with our portfolio companies to help devise “winterization plans.” We have gone through this exercise enough that we have seen some patterns that might be helpful to others as they create their own plans.
We agree with many of our peers that scenario planning is vital at this stage. This is a point that we have communicated repeatedly to our own companies. We have found that placing scenarios within a 36-month decision tree is particularly useful for preparing winterization plans.
Why 36 months when the usual feedback is 18 to 24 months of runway? We also believe that this downturn has the makings of a longer lasting and more volatile slump. A 36-month perspective is a more appropriate time horizon for collecting more information so you can decelerate even further (with cash to pivot) if things are worse in 12 months or accelerate if things are better in 18 months.
Chronological scenario planning forces you to set drop-dead dates to make decisions, all in the context of having enough cash on hand to gracefully pivot. It forces the company to think in an “if, then” structure that is much more actionable than siloed scenarios.
We hope the information below helps you create your own decision tree for winter. The sooner you embark on the exercise, the more your psychology can move from “fearful unknown” to “curious possibility” — and in these periods of volatility, psychology has an outsized impact on outcome.
Preparation
Before you can start creating your decision tree, you should ensure you have the following materials prepared.
Burn model
Have a detailed monthly burn model until “cash-out” for your current plan. This should include the usual categories like revenue, COGS, salaries, etc. Ensure you break out recurring internal expenses (office space, software subscriptions, etc.) from consultant fees, lawyer fees, from capital expenditures. Try to start separating essential from non-essential costs.
Two key points:
- Be honest with yourself on how well you actualize forecasts . Are you always spending more and making less than you project? That is a recipe for disaster when you are planning against burn. This is not a fundraising model; this is the time to be conservative with your numbers so you have a realistic picture of your expenses. If you don’t actualize your forecasts, start putting that discipline into the organization immediately. Once you close a month, look back at your forecast and see how you did. Getting good at forecasting and budgeting is a necessary skill in a tighter capital market. Get that skill now.
- Everyone regrets not making cuts sooner — often more than months too late. What you think is essential is likely not essential. I have unfortunately had to go through several scale-backs in my career, and I was always shocked at how much fat I considered to be muscle.
Updated organization plan
What is your current hiring plan? Has it changed in the past 10 weeks? Have you conducted performance reviews recently, and do you have an understanding of who your lower decile performers are at the company?
These are the difficult questions you need your organization to start answering, and the information you should start collecting if you haven’t already.
“Cash-to-profitability” number
What is the minimum amount of additional funding that gives you enough time to cut costs, grow revenue and become default alive at some point in the future?
This is the most important number you should always know at any given moment, because it is the amount of money you need for an infinite runway and, therefore, infinite possibilities. For some deep tech companies, this number is very large, because they only cross that threshold eight years from now. For others, the number is much smaller and profitability is near term. This number should not be constrained by a time horizon — it should be an honest number even if it is very large.
Knowing this number does not mean you should go out right now and cut all costs, kill growth, stop product progress, slow customer momentum and let go of all the talent you recruited. That would likely be completely suboptimal and not a recipe to thrive when good times roll around again. It does mean that you should already have an, often vicious, plan to get to default alive if you can. If you can raise your cash-to-profitability number and maintain that cash balance, you know you can survive.
Four scenarios
A 36-month decision tree does not mean you have 36 months of runway with your current plan. We are also not suggesting you cut all your costs and have 10 years of runway with just your salary and Google Suite. The process of creating a 36-month decision tree is a balance between continued progress and financial reality.
First, create four strategic scenarios with an associated burn rate for each:
- Plan A: The first scenario keeps your team in place but trims all the fat. Maybe you let go of some under-performers or you freeze hiring, etc. This is a budget that maintains the momentum of the organization, but shifts psychology from bull market to bear market. (You should already be in Plan A!)
- Plan B: The second scenario is a pared down set of milestones. You could focus on one market or one deployment rather than multiple to continue progress but save money. This is when you start cutting teams, projects, R&D budgets, etc. This budget allows for progress but reduces magnitude and pace.
- Plan C: The third scenario is to massively reduce team size and costs to maintain and grow non-exponentially. This plan is the proverbial “cockroach mode.”
- Plan D: The fourth and final scenario is a gracious wind-down that leaves money for severance and wrapping up the company.
Don’t fall into the zombie trap
Zombie mode is not on this list. Cutting all costs to survive without the ability to make progress is not really surviving. Do not confuse cockroach mode with zombie mode. Zombies are not investable. For your company to ever have the chance of surviving, it needs to be investable.
Default investable is a concept recently introduced by David Sacks as an alternative to default alive, which is an unrealistic standard for many early-stage companies. Default investable means a company can reach the requisite set of milestones to raise their next round in the current environment. A company that is not default investable will be at high risk to raise bridge capital on favorable terms.
Make sure you verify the milestones. Don’t assume that the previously set milestones or outcomes are still valid. Get feedback from potential investors, existing investors and advisers on the commercial and technical progress that will be required to unlock the next round.
Could you fund a 36-month decision tree?
With your four scenarios in hand, the second step is to lay out a 36-month timeline with the next key, verified, milestones for your business. Overlay the first scenario on this timeline and see how far you get. If you run out of money with your current plan, determine a drop-dead date to fundraise before moving to your second or third scenario. In this manner, you will start seeing what you need to do and when.
Iterate scenarios until you are able to extend your meaningful progress to 36 months along a certain execution path. Sometimes, this means that you have to raise a bridge on a smaller milestone. Sometimes, this means that a program you had fully funded gets pushed to your next fundraise to ensure you have time to raise that money.
For many people, this means a clear set of decisions that lead to the company winding down. The sooner you know how treacherous the road to surviving the next three years will be, the better you can prepare your organization for the journey.
We recommend that every company prepare burn-down charts for their different scenarios, including specific target dates for key milestones as well as drop-dead dates for fundraising.
12-month line
If you have less than 12 months of runway, the cuts need to be decisive, swift and likely much more painful than you are comfortable making now. Take some time to adjust your expectations and make the tough cuts. I have always regretted not making cuts six months earlier. Once cash leaves the bank account, you can’t get it back. Rip off the Band-Aid now.
You should also fundraise to extend your runway with urgency. It would be a huge win even if you can take money on a flat round. Reconsider your fundraising plans and raise less if you can raise it quickly.
Lastly, set firm drop-dead dates for cutting costs and raising more money. If you do not create 36 months of life for your current strategy, know when you will have to make adjustments and pivots to your strategy to survive. Maybe you get to 24 months and that feels great — you should still have a date 18 months from now so that, if you have not been able to extend your runway, you will make additional cuts.
Plan your pivots now
It will be of great psychological comfort for your organization to plan painful pivots months or even years in advance. Planning a pivot when your back is against the wall is difficult and leads to very suboptimal outcomes.
Create your pivot plans now: the date you will execute it, what cuts you will make, what severance reserves you will need, etc. Know where you would point the ship next and who you need on the ship with you. Leave ample room and cash to pivot from a position of strength rather than desperation. When it comes to more painful and unpleasant cost-cutting, like staff reduction or program defunding, you will be glad you had a plan.
We have spent over a decade being conditioned to plan for the upside. But getting really good at preparing for the downside will help you thrive through this next cycle.
For example, if you have several years of runway, you likely have mapped when you will hit certain milestones and when you will go out to raise that killer next round of funding. Have you also set a date by which, if you have not raised, you will have to let 25% of your workforce go? Have you thought about severance packages, and how much cash you should reserve to make those cuts gracefully and fairly for your employees?
Hopefully, you will never cross that pivot date. Hopefully, you will be able to raise more money or grow more profitably, and kick that pivot date further out. Or even better, you reach the point where you are maintaining your cash-to-profitability number.
This last point may be counterintuitive, but you should also always balance runway with progress. Most companies could cut all their employees except the founders and continue being “alive” for several years. As covered previously, no one really benefits from being in “zombie” mode. Your pivot plans should include progress even if it is a small subset of the original vision or even a different vision altogether.
If you have 36-months of runway
If you have 36 months of runway but do not have enough funds to enact a default-alive plan, you should still cut costs and double down on fiscal discipline (minimize travel, events, new office space, etc.) This is a great time to instill a culture of frugality — create discipline around monthly cash forecasting and actualization.
Also consider taking more money if you can. Even if it’s at a flat round, padding the budget is not a bad idea, especially if it will allow you to continue making progress and pick up more talent, technology or customers. This is a time of great opportunity for those who have cash. If your cash-to-profitability number is within reach, that should be your immediate fundraising target.
If you are in a stronger cash position with more runway, now is also the time to take a serious look at non-dilutive funding like government grants and programs. These are never short-term solutions, but if you have time, they could be a great way to extend your runway. Also include debt as part of your capital formation strategy.
Finally, maintain strict vigilance over your burn, runway and cash-to-profitability numbers. Reassess the market and your decision tree every quarter.
Survive to thrive
It can often feel self-serving when investors proselytize the apocalypse and capture the benefits of lower valuations. We hope this piece is more productive and provides some tactical steps to start scenario planning. We have been working closely over the past quarter with our portfolio companies to help them devise strategies to not only survive but also continue making progress. The suggestions above derive from all those conversations.
The problems many deep tech and climate tech companies are solving are just too important to fade into startup history. Companies that make it through this tough time will find themselves in much greener pastures: less competition, more talent and capital ready to fly to quality.
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