Many (probably most) startups go through periods of extremely little cash in the bank and with visions of crashing and burning before being able to recover. Unfortunately, crashing and burning is what actually happens somewhat often after getting extremely low on cash. But it’s not what always happens, and even if closing the company is the only option, there is a certain way to go about it. This article highlights some golden rules to keep in mind upon hitting really tough times, having doubts about survival, and deciding how to proceed.
Causes of Death
Before we get into ways to react to a near-death situation, let’s review the most common causes of startup failure. Below is the result of a survey conducted by CB Insights that can give us some suggestions. From my evaluation, I categorize at least 5 of the causes as a Fundamental Flaw of some sort and at least 11 as Execution Flaws. What I mean by “fundamental flaw” is the venture should not have proceeded past the point of Customer Discovery. For example, perhaps the market doesn’t suffer from the assumed pain or not enough to be willing to pay for a solution.
Soul Searching Time
Ultimately, when you are looking at a countdown clock that is getting close to zero, you have three choices. Hopefully you’ve got some trusted advisors and colleagues that can help you through this. While thinking about this, realize that most entrepreneurs are optimists and have trouble seeing the full picture. This is actually a valuable survival skill that serves entrepreneurs well most of the time because how else can they walk on a tightrope with burning fire and venomous snakes beneath them much of the time? But it also obscures their ability to make a 360 degree assessment of reality and options. Again, this is where trusted advisors and colleagues can be helpful.
The good news is that desperation tends to reveal options that were always in front of you but weren’t visible until you became desperate. Let’s explore a few of the most common ones.
Buy some time in hopes of a recovery
The main thing you need to decide is if additional time is going to allow you to solve the underlying issues. That doesn’t mean just making incremental improvements but rather achieving enough success to reach “escape velocity”, which either means becoming self-sustaining or attractive enough to raise money. And remember what I said about being an optimist.
If the main reason you’re facing the really tough times is due to a recession or other macro-market condition, then buying some time is probably exactly what you should pursue. But if, instead, it’s due to some fundamental flaw in your business plan, your best hope of longer-term survival requires a pivot. If that pivot is significant, trying to do so while you’re already facing potential death is going to take a miracle or huge luck.
Prepare to close/dissolve the company
I heard someone say there are only two reasons startups fail: the founders give up or they run out of money. I actually believe there are many instances in which the best thing to do is close the company, even if it has cash in the bank and a little runway left. In other words, the best outcome might be to hold your head high, give whatever return you can to investors and move on to your next gig.
If you pursue a dissolution of the company, don’t just focus on your legal/financial obligations. Spend serious time and effort trying to take care of the employees that devoted their energy and loyalty to your cause. The way you treat them and help them on the way out will say a lot about you and define your reputation going forward, should you ever want to try your hand with another startup venture. As for the legal and financial obligations, take them seriously and realize to do things properly will cost a little money. You will want to notify your customers and will want to provide a formal dissolution notice to your investors so they can at least get a benefit on their next tax return.
Pursue a sale of the company
Even if you built something really cool, your inability to create a growing and healthy business around it almost certainly means you will be selling in distress, which means a “fire sale” exit multiple if you are even that lucky (most attempts to sell a company in distress result in nothing). It is possible that the reason times are tough is due to something totally out of your control and there are three companies out there that will desperately fight to acquire you. But that is very rare and you should understand the dynamics of selling your company versus being bought (see related article titled “Are You Selling Your Company or is Someone Buying It?“). Also realize that pursuing the sale of the company likely requires board and/or shareholder approval.
Assuming you decide to buy more time in hopes of seeing better days, you’ve got to get into survival mode and prepare for some genuine ugliness. You know all those loyal employees that bought into your vision and poured their souls into achieving it? Well, 30% or more of them need to leave because you can’t afford them. That’s right, your first layoff. And the ones that get to stay, they are about to get a salary cut in exchange for additional equity and/or a catch-up payment when the company gets well. Hopefully they still believe in your vision enough to stay with you. Just make sure to whack the compensation of the founders and executive team by double the percentage as the employees. Here are some other things you must consider doing in order to get some runway:
- Slow pay your bills without causing key services to get terminated
- Negotiate reductions in other recurring bills like software licenses, office rent, etc. You might be surprised to find some vendors and service providers be willing to take less than full payment in hopes that you stay alive for a while.
- Raise money on a bridge note with very favorable terms. Investors will obviously need to know about the other actions you’re taking and the reason you think there’s still hope.
While you are taking these actions you should run fresh cash fume projections at least every month and possibly every week.
A survival technique I see some startups employ is to generate revenue from services, such as consulting. Lots of startups actually start out as services business and later build a product and shift in that direction. Those startups have the easiest time generating new services revenue, because they’ve done it before and probably still have customers they can approach again. Using this approach to survival is going to cause a lot of explaining to investors, as things recover and you’re able to focus back on the future business. But I’d rather survive and have some explaining to do versus crashing and burning.
For more info about transitioning from a services company to a product company, read my article titled “When Service Companies Build a Product“
Honesty & Communication
At times like this, emotions run high and true personalities come out. This is not the time to dance around the issues with your employees, investors and trusted advisors. Honesty buys loyalty and loyalty is possibly the strongest currency you can count on when times are really tough. Regardless of the option you selected during your soul searching (referenced above), be honest.
Make sure to inform your investors about the company status. Waiting until you’re on your last breath and about to die is not the right time for them to learn the company is in trouble. The sooner you can let them know you’re not pointed in a good direction and are considering some difficult actions, the better. In the worst case, you’ll end up dissolving but with some investor trust and respect intact. In the best case, the investors will offer some ideas and assistance that positively impacts your recovery.
Related Reading: This article titled “How Not to Die” by Paul Graham (Y Combinator co-founder) has tons of great insights to consider.
I’m sorry to report that there aren’t any spreadsheets or analytical exercises that can really help you with the needed decisions and associated actions. Tough times call for “gut checks”, reflecting on your founding principles (see related article titled, “Founding Principles – Do You Have Them?“), and deep thought. How’s your yoga?