tl;dr Don’t want your company to die? Here’s what to do.
The startup fundraising environment is in flux, and over the past two weeks the pace of change has accelerated rapidly. Throughout the ecosystem, blogging VCs and entrepreneurs alike are urging that it’s time to raise, even if you can’t get the valuation you hoped for. Others are reminding founders to think long and hard about the proper approach to deploying that hard won funding.
Valuation multiples are now compressing faster than most companies could possibly hope to grow, and founders who delay their fundraising for one more month of growth are in for a rude awakening. Growth is no longer enough. Stop waiting to make your graph prettier. It won’t make a difference.
You are putting your company’s existence, your employees jobs, and all the capital you’ve already raised from existing investors at risk by not fundraising right now.
Assuming you are not running a company at cash flow break even, you will need to rapidly triage your situation to start moving the needle today. The longer you wait to act, the fewer options will be open to you, but if you don’t think things through you risk making irrational decisions based on emotions. Take a deep breath.
Aggressively Triage Your Cash Position
The more money you have in the bank, the more runway — time — you have. The more time you have, the more room you have to slow down your timeline and make higher quality decisions. Runway gives you leverage, because when you don’t feel pressure to take what appears to be the only option on the table you open yourself up to other options.
Generate cash however possible and simultaneously cut expenses right away. If you can, offer existing monthly customers a slight discount in return for paying for the entire year up front (this is more specific to enterprise software companies). Cash is king.
Do not stall and do not let more than 2 payroll periods go between plan and execution. Break your lease, reduce your salaries, and assess who is doing the work that adds the most enterprise value and let all the other people go (there are laws about layoffs, get advice from an employment lawyer to avoid a company-killing lawsuit). Cut deeper than you think you need to, sooner than you think you have to. If the decision to keep someone is a coin toss, let them go.
Some useful recent benchmarks that depend slightly on your business model (Most of these assume you have revenue. If you don’t I have no idea how to help you.):
- $10-12k per employee max monthly burn (net cash loss after revenue) (Source: “How Much Cash Should Your Startup Burn” by Tom Tunguz, September 2014)
- 150 square feet per employee, all inclusive of common areas (Source: CoreNet Global, this is widely Google-able if you want a different source)
- 1 customer success / support per person per $2M in annual revenue (Source: “The $2 Million Dollar Man/Woman: How to Think About Scaling Your Customer Success Team” by Jason Lemkin, October 2013)
- 1 month of engineering spend trending toward < 50% monthly revenue (Source: “The Investment Patterns Of SaaS Companies In Sales And Engineering Over Time” by Tom Tunguz, April 2014) — This is where I believe companies are the most bloated, mostly due to inexperienced managers over hiring/paying for too little product velocity.
- Get to break even with each of your sales reps (Source: “The Other Payback Period That Matters In SaaS” by Tom Tunguz, February 2016)
This is the hardest part of being CEO. Tell your company and existing investors the complete unvarnished truth, do the necessary things, lean on your support network on nights and weekends, and stay focused on the survival of the company.
Run A Truly ‘Do or Die’ Fundraising Process
Ask yourself, honestly, do you believe your company is a venture-backable opportunity that can return 10x on investors money in the next 5 to 10 years? If you say yes, and you know it is the truth, get back in the game and keep taking meetings. Your job is to convince investors.
The days of ‘running a process’ in a couple weeks are over, and you’ll have to take a lot more rejection, but if you can relentlessly meet with everyone who could possibly fund you then you might just find the one. You only need one. [Editor’s note: YONO?]
SaaStr Annual 2016 by SaaStr on Livestream – Livestream.com
Increasing Optionality on Outcomes
If you are able to convert your note without raising a round, consider it a big win! Converting your notes stops the clock on interest (which will converts as equity in addition to the original loan), and it will clean up your cap table and make you easier for the next investor (or acquirer) who comes along to invest.
Set a clear path for you to get cash flow positive and weather the storm, and ask your existing investors to put in more money on the conversion terms if they are still strong believers. There are many wonderful angel/seed investors out there who have seen this movie before. Be open with them and ask for advice.
Reset Your Valuation Expectations
Converting your seed stage convertible notes is going to be difficult. A good startup lawyer can help navigate the logistics, and a few of the bigger note holders who you’ve maintained strong relationships with should be able to support you through the process. Don’t be surprised if your note gets converted to equity at a pre-money valuation that is at or below your cap.
It is important that you understand your company is significantly riskier now that it has failed to raise a traditional equity round from a deep pocketed fund, and adjust your expectations about valuation accordingly.
Reset Your Fundraising Timeline Expectations
3,686 companies have raised a cumulative $5.3 Billion in seed funding sometime in the past two years, but have not yet raised their Series A. Last year, 896 Series A deals were announced (the highest number in 10 years). Best case, only the top 25% of companies at this stage will make it to their Series A. The jobs of more than 32,000 employees hang in the balance.
It is commonly believed that the most dramatic winnowing of the funnel takes place at the Seed stage, but with an explosion of pre Series A deal activity as far back as 2012 has also expanded the pipeline of companies who are seeking their Series B. Our data shows there are 1,938 companies who have raised a cumulative $18.4 Billion in Series A funding sometime in the past two years, but have not yet raised a Series B. Last year, 548 Series B deals were announced. Assuming the same number of B rounds in 2016 this would suggest only 28% of Series A companies will graduate to the next round.
Your odds of graduating your startup from Seed round to Series B were 7%, assuming this year’s deal activity remains on par with the hottest market of the past 10 years. Adjust your expectations, it is going to get harder and it’s going to take longer to raise.
Live to See Another Day
I’ve been a CEO for just shy of four years now and have never operated in this role in an environment like the current one, so I am learning as we go. However, I do know that the CEO job has three fundamental responsibilities that are the ultimate drivers to company success: set overall vision and strategy, hire and retain the best talent, and keep enough cash in the bank.
At the end of the day, all you need to do is make sure your startup is still alive. Do whatever you need to do to ensure survival and then tune out all the noise. Whether it’s another round of funding or the cash flow positive route, a win is the goal here. It doesn’t really matter how many ‘points’ you score as long as you win the game. And the sooner you take the steps necessary to protect your company, the sooner you can get back to building your company for the long term.
If you have the endurance to ride out months or years of little to no salary, working long hours to make up for the headcount you can’t afford to hire, living with roommates even though you’re married and in your 30s now, you just might come out on the other side with something incredible. And when someone calls your startup a unicorn 10 years from now, you’ll smile serenely as you fantasize about punching them in the face.
Always stay gracious, best revenge is your paper. – Beyonce