May 2022 had more layoffs than March 2020 at the start of the pandemic, and June is on pace to ellipse May. The tech boom that started after the 2008 crisis is now over, and we’ve entered the part of the downturn where layoffs accelerate.
We started a poll among founders last week to see how many of them are planning layoffs and downsizing their fundraising plans for 2022, and the results show a concerning level of disregard for risk in my view. It seems that the full impact of the change in market conditions hasn’t set in yet with founders. I theorize that this might be related to the shocks followed by unsuspected booms – such as during Covid – lulling people into a sense of complacency.
Here are the poll results
- 92% of founders did not do layoffs during Covid
- 88% of founders have not done layoffs thus far in 2022
- 80% of founders are not planning any layoffs in 2022
- 92% of founders have not received pressure from their investors to do layoffs in 2022
- 60% of founders have a cash out date in the next 12 months
- 50% of founders do not plan any fundraising in 2022
- 50% of founders say that the events of 2022 have not changed their 12-32 month plans at all
This week, as markets have continued to tank, we’ve started to see public sentiment shift dramatically on tech Twitter, and when the layoff numbers for June became clear, I think that we’ll see more founders sober up during the summer, plan layoffs, and curtail fundraising plans.
With this in mind, let’s dive into how to plan a reset to gain additional runway, and how to run the corresponding layoff processes with as much dignity and grace as possible.
Reset planning – getting to 24 months runway
Y Combinator tells founders who raise money to act as if it’s the last they’ll ever get. – Paul Graham, The Fatal Pinch
The conventional wisdom is that startups should always endeavor to have 24 months of runway, and never less than 12. If you are negotiating a fundraise or an acquisition with less than 6 months of runway, you will have no leverage and the risk of failure is enormous. So we try to stay as far away from that risk as possible.
One of the things that makes the fatal pinch so dangerous is that it’s self-reinforcing. Founders overestimate their chances of raising more money, and so are slack about reaching profitability, which further decreases their chances of raising money…What do you do if you’re already in the fatal pinch? The first step is to re-evaluate the probability of raising more money. I will now, by an amazing feat of clairvoyance, do this for you: the probability is zero. – Paul Graham, The Fatal Pinch
Beware of this counterproductive set of anti-patterns
Investors will continue to fund my company if I run out of money.
If I fail at fundraising I can just sell the company.
My conversations with potential acquirers or investors are very far along and likely to happen.
Acquirers won’t buy us if I cut costs.
My employee morale will plummet if I cut costs.
New investors won’t fund us if I cut costs.
Sometimes you get into a bad spot with your runway, and you need to hit reset. When that happens, it’s time to step back and re-plan. Keep it simple. Running a business can be enormously complex. Resist the temptation to revisit everything from first principles and consider every contingency. The only way to increase runway is to increase revenue, cut burn, or raise money. Hopefully as a startup you’re already trying to grow your revenue as fast as possible so growing your way out of this is unlikely a realistic solution. If there is a chance you can raise funds to avoid getting into crisis mode then you should do so now. So when you’re resetting you’re probably mostly looking at how to cut burn and what milestones you need to get to in order to raise additional capital.
That said, you can’t just cut costs and stagnate. You need to understand the milestones you need to achieve in order to become profitable or raise additional capital. So this is going to require that you’re getting additional commercial traction and building whatever you need to build in order to support that traction.
Here’s a sequential process to help cut burn
- Create a basic financial plan assuming *realistic* revenue growth and try to target 24 months (or as close to it as you can get) of runway. Maximizing your runway implies how much burn you need to cut to get there, which is normally going to be 20%+.
- Decide whether you are happy with the team’s performance or whether performance issues are part of what got you into the current circumstances. It’s normal that issues have stacked up over time and, when you come to the point of requiring a reset, you have some performance debt among other things.
- If you have performance issues to deal with, conduct the evaluation to determine who to lay off for performance reasons. Then I would conduct the operating expense reduction, and only then finally look at what target burn reduction is left over that requires further layoffs purely based on reducing burn. Even if you make all the cuts at once, it’s important for management to separate these matters in their minds in order to plan more efficiently and avoid conflating multiple issues that have stacked up over time leading up to this reset.
- Once you have outlined the folks you need to let go for performance reasons, look at everything else you can possibly cut besides headcount. This should include any outsourced services and often these should be the first thing on the chopping block. Cut any nice to have or incremental operating expenses or things that people might claim make them more efficient but aren’t necessary right now. It’s very important to distinguish activities you should be investing in with investor capital versus your own profits. There are only a small handful of core existential bets that startups are meant to make with investor capital to prove out their core business, and only then should startups proceed to broaden the horizon. It’s important to dig as deep as you can into operating expenses because every penny that you can’t find in operating expenses is going to have to come from layoffs.
- Be honest with where you are commercially. Poll next-stage investors to gauge their expectations around traction, and work backwards to determine what your growth expectations should be. Then plan your commercial team resourcing and product roadmap around these targets.
- After you measure how much you’ve leaned out then you need to decide how much burn to take out of the organization through layoffs. Next let’s look at all the details of planning the layoff.
Veteran founder and investor Pete Flint has a number of great suggestions in his post 39 Moves to Survive and Thrive in a Downturn. Focus especially on the sections on cutting burn, incentivizing top performers with additional grants, and gaining ground.
Planning the layoff
The first rule of planning layoffs is to cut deep. You never want to end up doing multiple rounds of cuts – you’re just going to annihilate the team’s morale and everyone will be looking for jobs instead of trying to save the ship. Use the burn and runway exercise to make your exact decision, but a general rule of thumb is that 15-20% is going to be the low side, 30%+ is going to be the high side, and if you’ve let things get to the extreme where 50%+ is required, you’re almost creating a totally new company.
When I moved out to Silicon Valley I joined a high flying startup backed by Sequoia and Matrix. The company grew from 120 to 150 people, and then shrank to ~12 people over 5 rounds of layoffs as the internet bubble imploded. I got laid off in the 3rd round. It would have been better for the company to do one big cut up front and preserve cash than to wait through multiple layoffs and keep burning large sums of money. Repeated layoffs devastated morale at the company. – Elad Gil, Startup Offense and Defense in the Recession
Here’s a sequential process to help decide on layoffs
- As soon as you become aware you need to revise your financial plan and do a strategic reset, you need to make layoffs part of this plan. You should absolutely not communicate this revised plan to the team and *then* do layoffs. You need to roll out layoffs as part of the plan, and communicate the new plan only to the team that’s staying.
- Founders and core leadership (execs and people ops / HR) should be involved in the layoff planning process. These leaders should involve managers and key people as required in the process of deciding upon and carrying out the cuts. For example if there are cuts on an engineering team, you probably want key managers and tech leads involved – with the caveat that you need to limit the pool of those involved to those who can manage sensitive HR information.
- Reiterating from above, first run a process to decide any people or teams that need to go for performance reasons. Performance debt is a real issue and it’s common that it builds up and gets addressed during resets. Don’t shy away from addressing this separately from pure cost-cutting, because many of the folks you have to let go for cost cutting are folks that you’d rather keep but just can’t justify the burn for right now.
- Next, I recommend going top down
- Are there any execs that can go?
- Execs typically have the highest cash burn
- Startups commonly overhire execs as part of speculative scaling. Clear signs of this are when you have an exec with a single digit headcount on their team. You might even have execs with ICs reporting directly rather than managers. In that case, you really need a manager not an exec, or you need a simpler org with a larger number of people rolling up to execs and founders.
- Do we need every org? Whole orgs are often easy cuts.
- Are there any execs that can go?
- How much to cut each org you are keeping? Is there clear reasoning for where you can downsize most?
- This can be tricky. You need to balance the need to grow commercial traction and build product against the need to cut burn, and of course leaders are all going to fight to retain as much of their teams as they can in order to deliver on what they need to. This is where the CEOs role is really critical – you must continue challenging everyone to cut as deeply as they can, and sometimes you need to give people a ‘sandbox to play in’ with some parameters.
- What do we do with management layers? How do we engage management who we need to cut but who we also need to help run the layoff process?
- I talk about this more in the comms section below, but I always recommend being fully transparent with managers and engaging them fully in the process even if they are also going to be transitioning out. You do this by ensuring everyone is being treated fairly with their exit package – good managers will stick around to take care of their team and transition out gracefully like professionals as long as they are being treated professionally with the exit package in return.
- Are we sure we’re retaining the capacity to grow traction and build the product to the extent we need to get to the next milestones?
- This is a double-check on how much we’re cutting from each org and why. You want to be especially sure you’re not cutting too much in areas like engineering and sales which are the engines of building and selling your product.
- It’s OK to let some areas fall behind and get into a funky state – remember it’s life or death. The company can live without certain ops processes running as smoothly as they should, but it can’t live without more commercial traction.
- Do we have second order decisions to make like extended offers, recruiting, or interns?
- If you’re entering a hiring freeze for some period of months, you’re probably not doing yourself any favors keeping the recruiting team on.
- You should probably also not be onboarding new team members, including already extended offers.
- Other high-touch and not long term full time help like interns or consultants should be cut. You need only people that are going to be fully dedicated to seeing the company through this difficult time and have an intense vested interest in success.
- What do we do about tactics like severance, benefits, notification date and when people stop working, and company property especially when operating remote?
- Lots of great answers to these from David Ulevitch from a16z. I mostly agree with all this so I’ll just refer to his post.
Comms is probably an even more gut wrenching part of the process than deciding on cuts. The team appreciates directness and as much economics and benefits as you can give them. The Airbnb Covid layoff was executed well in this regard:
Severance: Employees in the US will receive 14 weeks of base pay, plus one additional week for every year at Airbnb. Tenure will be rounded to the nearest year. For example, if someone has been at Airbnb for 3 years and 7 months, they will get an additional 4 weeks of salary, or 18 weeks of total pay. Outside the US, all employees will receive at least 14 weeks of pay, plus tenure increases consistent with their country-specific practices.
Equity: We are dropping the one-year cliff on equity for everyone we’ve hired in the past year so that everyone departing, regardless of how long they have been here, is a shareholder. Additionally, everyone leaving is eligible for the May 25 vesting date.
Healthcare: In the midst of a global health crisis of unknown duration, we want to limit the burden of healthcare costs. In the US, we will cover 12 months of health insurance through COBRA. In all other countries, we will cover health insurance costs through the end of 2020. This is because we’re either legally unable to continue coverage, or our current plans will not allow for an extension. We will also provide four months of mental health support through KonTerra.
Spare the team the rest of the details, your personal sob story about how hard this is for you, or waffling around among various reasons for the cuts. Read up on Better.com’s recent layoffs as an example of comms struggles.
Once you communicate layoffs to the team, their first questions are going to be “are there going to be more layoffs? What’s going to happen to me? What happened to my colleagues who are gone now?” This is why how you treat outgoing employees is key, including offering the most generous severance and benefits packages you can muster. Not only is it the right and most empathetic thing to do as management, but it’s also critical to creating emotional safety among the team that’s staying, because they can see people are being treated fairly and transparently, even on the way out.
Here’s a sequential process for comms
- As a precursor to everything else, typically when you’re conducting layoffs it’s going to be at multiple levels including managers and folks on their team. Some people will have the managers fire the people on their teams and then fire the managers afterwards. I think that’s just despicable and normally correlates with trying to cheapskate managers on their exit packages. Just muster some courage and bring managers into the process, offer them a good package, and give them the dignity of carrying out what needs to be done with their teams and with themselves. Managers always appreciate being treated with that respect and given that agency.
- First, managers should do 1:1s with those affected. Some people think that an HR person should be present, but this depends on stage, culture and policy – it’s not strictly necessary.
- Next, do an all hands immediately afterward with those who are staying. This minimizes time for gossip with the wrong message circulating around among the team.
- Do not invite the folks that are leaving to all hands. Although this may seem counterintuitive, if you have built a truly exceptional company culture, it can be appropriate to have a going away party for people as a chance for everyone to connect, share contact info, and for everyone to express their warm feelings and well wishes to the departing team. It’s also appropriate to help folks with job searches, put up a public list of their roles and contact to help them get inbound for their job search, and offer to provide references or anything else that’ll help them – even having others on the team help reach out through their networks and even do mock interviews to help the outgoing folks find and prepare for new opportunities.
- If rumors start spreading or you are noticing a rapid decline in morale, have a meeting with all managers for open roundtable discussion and send them off to do 1:1s, then do the same and have an all hands and allow everything to be aired openly. It’s important everyone is heard and that real concerns are addressed with real actions.
The CEO should address the company in a similar way to a new CEO taking over, but starting by owning their own failures that are leading to the layoffs. The CEO should start by stressing that they are ultimately accountable for letting the company get into this position whether through overhiring, not anticipating market conditions, or what have you. The reason is less relevant than the willingness to take ownership and not point the finger. Whatever the case may be, here we are, I own it as CEO, and here’s why this is necessary to position us to make it out alive and to the next stage of building the business. Here’s what’s going to change now and why these are the right changes. Now I want to open the floor to any questions about both our decisions in this process and our plans for the future.
Referring again to David Ulevitch’s post from a16z, I think there are some solid comms advice at the bottom that are also well worth the read.