Until startups are profitable while growing, they are burning down cash against a finite runway that’s usually less than two years away. As a result, it’s important to have a realistic plan at all times for what it will take to i) raise additional capital, ii) become profitable, or iii) fall back to m&a or wind down.
Keepin’ the dream alive
Founders and early employees are usually excited about some big vision and have personal reasons for wanting it to come to fruition. This creates a strong confirmation bias, and often makes us wholly unable to look in the mirror and reflect on where the startup is actually at relative to its goals and relative to how we’re seen by the outside world. Many times this will result in not setting clear and measurable goals at all, not planning milestones against our goals, or abandoning any form of regular cadence of evaluation. When startups get into this state, I call it “keepin’ the dream alive,” in honor of the fantasy world we live in when we ignore the realistic issues of market, product, team and certainty of impending cash out.
Defining the target state: what it takes to get to profitability or complete successful fundraising
For a startup to be a going concern, it needs to be profitable or financeable. It’s unwise to rely upon inside investors to bridge you through difficult times. Instead, start by polling target investors on what kind of traction they’d like to see for your kind of business. The smartest investors should be able to give you a rough sense such as “I’d usually like to see at least ten mid sized SaaS logos for a Series A, but YMMV based on the specifics.”
Let’s say you are a seed stage SaaS startup that asks around and finds that the consensus for a Series A is about ten logos, you have twelve months of cash left at current burn, only five logos paying real money, and you aren’t growing fast enough to have ten within the next six months. In general, you want to start raising money when you have six to twelve months of cash left. If you’re not going to get to the point that outside investors will likely invest, you need to be talking among leadership and then the board (or lead investors) whether you can change to grow fast enough, whether it’s worth trying to pitch some new outside investors anyway, whether the inside investors would want to invest to extend runway if it seems like a growth inflection is near, or last whether it makes sense to engage potential acquirers or wind down the company.
If you want to become profitable, you just need to see how much it costs to sell and build as much as you need to and maintain operating costs, and ensure that you’re able to make at least this amount, ideally with some 20% buffer or more so that you’re not truly living month to month or quarter to quarter — which can be incredibly stressful on a startup and lead to attrition issues that make it impossible to break out of the catch 22 death spiral of ‘need cash to attract and retain talent, but need talent to generate cash.’
So whether you’re shooting for raising a round or becoming profitable, you need clear target metrics; either consensus VC metrics for a fundraise at your next stage, or clear operating metrics and revenue targets that will allow you to be profitable enough that you aren’t living month to month or quarter to quarter and shedding top talent due to the uncertainty.
The scientific startup operating mindset and how to avoid keepin’ the dream alive
Once you have a target state in mind, work backwards from there to define a series of milestones. You need to break the bigger goal down into steps that will let you evaluate and pivot — so they need to be quarterly at the longest, and should probably be monthly. If you have a growth rate to increase, or a burn rate to decrease, you need to make it operationally realistic — how fast can the rate of change really change, and does it happen in discrete chunks or continuously?
I like the concept of lead vs lag measures. Let’s say you have a typical growth target based on what VCs are looking for in your next round, like growing your # of logos paying you more than $X a month, or increasing your number of retained signups from inbound marketing efforts. This target metric is slower moving, and should probably be reviewed as a leadership team monthly and with the board or lead investors during monthly update emails/chats, and formal meetings quarterly.
The more important operating measures to the CEO and leadership are the fast moving lead measures that the team believes will drive outcomes in this lag measure. For example it might be that we know we can close about 10% of fully qualified leads who use the free demo version of the product according to some qualification criteria, then if we need 10 new logos, we know we will need to get 100 fully qualified leads to use the free demo. If we know about 5% of the good leads we hit the site with will convert into qualifieds, then we need to drive about 2000 good leads (100/.05) to the site. So if there’s a number to track and discuss as a leadership team each week, it’s probably how many leads we’re driving — unless we start to see that our estimates of funnel conversion are off, or we think that we can drive more signups by increasing conversion at key points in the funnel, which is often the case. Most likely we have some combination of driving new leads as well as optimizing our sales and onboarding process to increase conversion and retention at each step.
If our lead measure isn’t moving our lag measure the way we think, then in this example something is wrong about our conversion estimates. If we move the lead measure how we want but we don’t move the lag measure how we want, then it always means that something is wrong in our understanding of how inputs drive outcomes, and we need to talk among leadership and do some testing and measuring so that we understand better how to do the right work to drive the results we want. It’s not simply about working harder when the work is getting the right immediate results but not the right outcomes — for example you might have loads of signups or sales calls but you’re not closing any paying customers on a timeline that works for the goals.
You can always create lead measures that are your best guess at what will precede the lag measures you want. For example if you are working on huge enterprise clients and have a smaller number of target clients, you can still guess at what kind of early stage time commitment activities you’d need to see with a client — such as calls or workshops — that would indicate progress. Even if you’re working on something binary like a technological breakthrough or drug development, you still have phase-based milestones for your overall project and leading indicators on your progress within each phase.
“Good board meetings are those where the numbers are good”
— grizzled old CEOs
Inside a company, we see all kinds of things, and many of them look good, especially considering our confirmation bias. To the outside world, and especially to investors, the company is reduced to an elevator pitch of its core product and its metrics. We need to review these metrics periodically and soberly, and if we’re focused on growth, then we need to use any insights from reviewing lead indicators as opportunities to pivot and run experiments that aim to grow our metrics faster.
Always remember that uncertainty is super high and what you are trying to do is nearly impossible; these are defining aspects of startups. Therefore, don’t be afraid to acknowledge that there are some massive issues — there pretty much always are! This is why it’s so important to remind the team “let’s not get caught keepin’ the dream alive, let’s be rigorous and ask if we’re making the progress we need to be and what we could be doing better.”
When the numbers don’t look how you’d like, there are often significant market, product, or team issues, not just small tweaks. Either the i) market’s not there in terms of size or timing, ii) the product isn’t what the market actually wants and needs, or iii) the team isn’t able to execute on product and go to market — they can’t build and sell what people want.
Have hard conversations as a leadership team and with your board. Don’t be afraid to ask the existential questions. When we review fast moving lead measures with leadership and see that the numbers aren’t changing the way we need, then we have to ask which things aren’t working and be prepared to make major change.
This might mean totally changing the market you’re focused on — which may mean pivoting the product and team with some small cuts and additions to both, or it may mean sunsetting the product and having a massive layoff, then rebuilding the team and product from scratch.
This might mean changing the product by doing a lot of rapid customer interaction like interviewing, shadowing, metrics forensics, and synthesizing out some key ideas for reworking the product until to align to the wants and needs of our customers.
Lastly, the team being unable to execute is among the most common reasons that you’re not moving the numbers the way you need to be. The CEO needs to be willing to start with looking in the mirror — are they the problem and would someone else be a better CEO? If they’re confident enough that they’re as good as anybody for now, then what’s the next place where the results don’t seem good and the team doesn’t seem strong — is it sales, product, maybe engineering? This debugging process is pretty simple if you’re executing well with decent metrics and reporting. Is engineering shipping slowly and having lots of production bugs? Tech debt and weak technical leadership is probably an issue. Is everyone grumpy, opinionated about direction, and not aligned on what you’re shipping? Product is probably weak. Are we shipping regularly but not closing customers, and we can’t get enough feedback because we’re not getting enough customers to try the product? Market and sales are probably too weak to drive leads and deliver customers.
Of course there’s nuance here too — especially between product and sales, but these can often be easily resolved. If we’re hitting some basic leadgen and sales pipeline KPIs, and getting the product in front of customers, but we’re not closing customers, then marketing and sales are probably working and the product is off. If we’re shipping regularly and evolving the product in a way that satisfies us internally, but still getting nowhere with customers, then the market opportunity probably isn’t there, so we may need a big pivot rather than tweaks to the team.
“It aint’ gonna smell any better in six months.”
— grizzled old CEOs
The CEO needs to first ask themselves if they need to make a leadership change. Start with hypotheses about what’s happening, and go ask the relevant leaders what they think. Do they agree with the hypothesis and what do they think is wrong? Their response is probably a good signal to the CEO as to whether they seem on top of it and the CEO should trust and let them try to address, or if the leader is wandering the wilderness and pointing the finger. In the latter case, the CEO may want to get an outside advisor to take a second look and help swap the leader out with someone who might be more capable. Remember, there isn’t much time for these team changes, and it’s so common you’ll need to do it at least once or twice in each stage. If you wait 6 months too late, you might kill the company. As the CEO, if you’ve got the wrong leaders in place, then you own it and you need to act rather than avoid conflict.
The harsh reality of the stage gates
Startups are beasts of momentum — highly sensitive to initial conditions and success begets success. Some, like Peter Thiel, don’t think startups are even fixable once they get funky early on. There are some counterexamples like Slack’s pivot from Tiny Spek, but these are super duper unlikely and random — not something to count on or plan for as a serious option.
VCs largely want to see really great founding teams of world class people with strong founder-market fit and sane cap tables from inception. It doesn’t always have to be an equal equity split among co-founders, but the distribution should be more even than not and every needs >10%. Solo founders are less ideal, just because you can’t show the same breadth and depth of skill for attacking the product and market. Still, it’s OK to be a solo founder but one must come to the table humbly and with an expectation that they are going to be quickly building a leadership team and reserving maybe up to 50% of the company for them. What VCs don’t want to see is that there’s no well rounded founding leadership team and no clear plan to allocate the equity that’s needed to attract early stage leaders. Such a company is most likely doomed to fail, and even if it gets lucky is doomed for massive dilution as the leadership team needs to be built. When you need the people to get the traction rather than having the traction to attract the people, then you need to attract them with upside they can’t get anywhere else, and that’s only possible with founder level equity. If you’re going to treat this as executive search, then you’re going to have adverse selection bias — nobody would take the same equity from you with a way lower salary then they can get from a later stage company with a way higher salary, unless they aren’t good enough to get those jobs.
So even coming out of the founding phase into the pre-seed and seed stage, a startup is already under high expectations and being evaluated against historical founding team and cap table success patterns.
As you hit the pre-seed, seed, and Series A stages, you first have to wade through the ebb and flow of VC cycles. These stages are pretty nonsense and keep changing as the startup market goes through boom-bust sequences. There are really just two discrete steps that matter here — either you’re selling the dream or you’re selling the traction. If you’re selling the dream, then you’re pre-seed, seed, or whatever it becomes fashionable to call it before you have any traction. This includes if you have a tiny bit of traction that sorta shows directionally that you might be right, but not much else. Pre-seed and Seed investors are looking more for awesome founders with a great vision and something that would make for a strong one page investment brief with beefy sections for market, timing, product, distribution, or whatever their key criteria area.
If you’re raising a Series A, this is the point where you’re really doing it on traction. You might have some rapid initial growth that peters out, and that’s the risk VCs take when writing Series A checks — but you should be growing rapidly and look like you have some hope of continuing to do so, otherwise the Series A VCs aren’t doing their jobs.
Series A investors are looking more for some key metrics they track based on the kinds of businesses they focus on. These investors should be a broad set of deal flow and tracking the top performing startups in their areas of focus such that they are well calibrated to the kind of traction they’re looking for in order to determine that an opportunity is extraordinary and they should invest immediately. If the VCs aren’t doing this they just aren’t very good and aren’t a valid use of founder time for polling to get market consensus on desired traction for their startup. There are a lot of social proof VCs out there who just wait around backchanneling to see what others are going to do. Founders are best to avoid wasting time with second rate investors who can’t give a read of their respective markets — after all, if they can’t even do that, then what can they do?
As you get into Series B onwards, the VCs look more and more like growth investors and ultimately public market investors, and these stages are progressively dominated by quants. The spreadsheet jockeys descend and your company becomes an exercise in discounting future cash flows more so than evaluating the founders and their vision. The good news is that these folks can increasingly provide assessments of what kinds of metrics they are looking for in companies like yours at their respective stages.
Time between stages matters — take too long and it reduces odds you can make it to the next. This is simply because the best startups grow really fast so investors are always seeing that some of their portfolio and new deal flow are growing way faster than others. Those growing the fastest obviously attract VC capital and attention. So if you are taking longer to grow into the same traction when compared to a peer startup, then you’ve already shown that you’re growth rate is lower and that even with the additional time it took to grow, you weren’t able to somehow improve your growth rate — so it tells them two bad things about your growth. Startups that operate really well also just continue to do so, and therefore if we assume we’re always raising and planning 24 months ahead, then we’re going to be always hitting our goals and raising again. If anything changes, it’ll be that we’re raising earlier on higher valuation than planned as we exceed our goals. So those that are taking longer than 24 months between stages and stretching things out to try and show more traction raise red flags for VCs that you are growing slowly, unable to improve your growth rate, and also probably executing less well.
If you get too far off cadence between stages, it might be very hard to raise, and even inside investors may not want to continue funding your company. If you are worried that you might get into this state sometime in the next 12 months, then you may want to consider cutting burn and going for profitability, which can be a way of hitting the reset button. You can stabilize and explore whether its possible to rapidly increase growth and get back on track, or if you should just keep growing on profits or sell because growth-hungry VC funding no longer makes sense.
M&A and wind down as fallback strategies
Like raising capital or attaining profitability, you need to start M&A discussions 6-12 months before cash out. Failing to realize this is a common oversight, and you see a lot of startups attempting chaotic fire sales while playing payroll chicken with impending cash out. There’s no shame in discussing M&A alongside fundraising and monthly burn and profitability. More startups will be acquired than go public and be long term independent, so it’s a likely outcome anyhow and not one to be embarrassed or awkward about. Oftentimes, prospective buyers are tangential in the industry — even customers or partners — so some care is needed in running M&A interactions alongside other commercial interactions. Doing so is common though, and provides great signal for the M&A and fundraising as long as one plays both sides correctly and prospects know that you have strategic traction with other acquirers and investors. There are a multitude of tricky configurations, and its too hard to go into here — seek advisors with deep experience to help if you find yourself at a crux point. If you wait until the 11th hour, you will be out of cash, less attractive to an acquirer, shedding top talent, and any VC or acquirer will have tremendous leverage they will use to hammer you on terms.
Last and saddest for all involved is when it seems fundraising and M&A are both failing, cash out is approaching, and it seems the company may need to wind down. If the team is holding strong, then founders should be exploring all possible options to keep the team together working on something meaningful for them. Founders are responsible to shareholders, and if its clear there’s not going to be an investor outcome, then we must fallback to optimizing purely for the team. If we can’t find a strategic option to keep the team together, then plan a bit ahead to ensure we can meet payroll and help with some career coaching to provide a springboard for job searches. Again, seek a seasoned startup professional with experience winding down startups.
Set milestones pensively and stay accountable to realities
Firstly and most importantly, you need to start with a realistic assessment of what it’s going to take to raise additional capital or get profitable, and then work backwards from that leaving 6-12 months to get your numbers to the target state for the final raise or profitability push.
Next you need to treat these slow moving milestones as market reality inputs into your planning. Then use your experience, metrics, and discussions with other startups in your market to work backwards and define fast moving leading indicators that you can measure and discuss monthly with leadership and drive decisions about pivots.
If you don’t create a culture of #realtalk, then all this will be moot. It’s incredibly common to see smart teams keepin’ the dream alive because they just won’t look in the mirror and ask the hard questions about what the data is telling them about themselves — is the market even there, is the product really what people want and need and what tells us that, and can the team really deliver on this opportunity or do we have wrong or missing team members?
It’s important to be rational about parallel tracking strategic options between profitability, fundraising, and M&A — we’d all like to build a long term independent business worth billions of dollars, but that’s not always possible. If we can’t grow fast enough to raise cash or find a way to be profitable, we’ll have a hard time finding enough time for M&A fire sales after a failed fundraising or product death march leaves us near cash out with a burned out team.
Dig deep and have the courage to make the hard decisions
Don’t get caught keepin’ the dream alive, feeling depressed as you shut your company down, looking backwards wondering what could have been if you’d only taken more aggressive action when it was clear things weren’t working. Be optimistic about your vision, but scientific about your execution. Approach milestoning pensively, not with rosy optimism. Work backwards from market realities needed to make it to the next stage of the business, and track fast moving indicators that tell you if you’re likely to get there. Set a steady cadence of reflection and accountability, and if you aren’t moving the leading indicators the way you need to be, then dig deep and have the courage to make the hard decisions about pivoting markets, products, or teams.
Good luck and Godspeed!