Which way is up? The end of free money and the importance of keeping cash on hand

It’s always hard to run a startup, but at least in 2021, you knew what you were supposed to do: Grow fast.

Now, it’s not so simple.

At your board meetings, you have one investor complaining that you aren’t growing fast enough, another complaining that your burn ratio is too high and another warning you to extend your cash runway. You know you can’t please everyone all the time, but it would be nice to feel like you can please someone sometimes!

Ultimately, it’s not your job to please anyone. You have to choose the right path for your company. In the end, what matters is building a great company — and, a lot of that depends, quite simply, on not running out of money.

Here are my thoughts on how to approach this issue based on my experience as a former CEO and current board member and adviser to several technology companies.

Money is no longer “free,” and that changes everything

When interest rates were near zero, future revenues and profits were nearly as good as revenues and profits today. Capital markets were willing to make massive investments to build what investors believed would be strong profit streams far into the future.

The playbook: Pour money into sales and marketing and become a category leader; eventually, as the market recognizes your leadership, revenue will accelerate. Efficiency in the present didn’t matter because in the future — when the company had scale, a stronger brand, a more mature product and a more educated end user — efficiency would increase.

Well, investors today care about the less-distant future. They care about how much money they need to put into your company to get to that future and when it will arrive. If you can earn more than 6% with investment-grade bonds, speculative earnings that are 20, 30, 40 or 50 years into the future aren’t nearly as valuable as they were when interest rates were near zero.

You aren’t the only one who is confused and stressed

If you raised money in 2020 or 2021, you don’t know what a tough fundraising environment is like, and you’re likely getting contradictory advice from investors and advisers.

Why the contradictory advice? In many cases, your investors are equally confused. Some of them have been through downturns and some haven’t. Some have held operating roles, while others didn’t. However, all of them want to see their investment succeed, and many face pressure to deliver good news.

For some of them, you are their star company and their hopes and dreams rest in your hands; others may have a decacorn IPO in the wings and it doesn’t matter whether their stake in your company is worth $0 or $50 million — it’s not going to affect their lives or careers.

When they don’t know what to do or how to get to the outcome everyone wants, they just tell you to do something good: Grow faster, burn less money or be more efficient.

Prime directive: Don’t run out of cash

Someone once told me that successful companies each succeed in their own way, but companies all fail the same way: They run out of cash.

You could say that running out of cash is a symptom of some deeper problem like poor product-market fit, bad timing, sales execution, a botched fundraise or the wrong team. Whatever the cause behind this symptom, the death is clear enough. It may feel like there are a lot of things you “must” do, but you can’t do any of those things if you are out of money.

They say time is the one thing you can’t buy, but in fact, time is the easiest thing to buy at a startup. Buy less of other things and you will be left with more time.

Say you have $10 million in annual revenue, which is static, and $10 million in cash. Your current gross burn is $5 million a quarter, so your net burn is $2.5 million a quarter and you are out of cash in 12 months. In those 12 months, you need to accomplish something that will convince investors to give you more money.

Instead, if you cut expenses to $3.75 million a quarter, your net burn goes down to $1.25 million, and you now have two years to make something good happen. You have fewer resources with which to make progress, but you get more time. Everyone knows that twice the team often doesn’t build something twice as fast; but perhaps three-quarters of the team for twice as long is more likely to succeed?

Taking things a step further, if you can operate the company on $2.5 million in gross burn, you’ve broken even and you have all the time you need to figure out how to get the company growing.

Of course, this is an oversimplification. Cutting too deeply can imperil retention as well as your competitive position. But right now, it feels to me that most executives are more wedded to their existing plans than they ought to be, and they should be strongly considering options that buy them time.

Envision a realistic future state and a glide path to get there

Anyone who starts a company has to be something of a dreamer. It takes a bit of insanity mixed with ambition, salesmanship, technical acumen and a whole lot of hard work to get a company off the ground. An awful lot of what we in the startup world do is imagine, describe and sell our dream to everyone around us.

In tough times, we can’t try to just pounce on the dream and grab it. We imagine our company doubling revenue every year on its way to billions of dollars. But if our sales efficiency is low, even if we achieved the growth we are aiming for quickly, it wouldn’t be sustainable enough to raise money in this environment. We can floor the accelerator in pursuit of our dreams, but we might drive the company straight off a cliff.

In many cases, it is far wiser to be realistic and acknowledge that the company isn’t ready to grow at that pace. This lets us do two things:

1. Build a plan to grow at a realistic pace with a realistic amount of operational leverage and eventually get to break-even.
2. Make changes to the company — usually the product — that helps it sell more efficiently.

If those changes are successful, we can afford to add resources to grow faster. Meanwhile, if our plans for the product don’t pan out, we still have a sustainable company and time to regroup.

Think about a company that’s getting $40 million in revenue and adding $10 million per year at 75% gross margins. It has operating costs of $60 million, so it is burning $30 million a year. Its break-even probably looks like:

1. $80 million in revenue with the same $60 million in operating costs and 75% gross margins.
2. $60 million in revenue, $40 million in operating costs and 80% gross margins.

Let’s assume it’s the second scenario: You cut operating costs to $40 million now and ramp up gross margin over two years while continuing to add $10 million a year in revenue. This year, you burn $10 million, next year about $5 million and achieve break-even in year three, burning $15 million along the way.

Or, you could freeze operating costs and stop improving gross margins. You stand to burn $30 million this year, $22.5 million next year, eventually burning $75 million to achieve break-even four years from now. It might be easier operationally, but you may not have $75 million to get there.

It’s critical to think through such scenarios when markets are difficult.

I don’t have a silver bullet. There is no one right answer for every company in tough times, but I hope these approaches to thinking through your challenges are helpful.