‘Just break even’ may be the worst possible advice for startups in turbulent times

The economic turbulence of the last two years has forced startups to look for new survival strategies. Today, startups generally fall into two camps: a minority that can afford to continue doing business as usual because they have a strong market position and a powerful financial base and the majority that is forced to adapt to ever-changing conditions.

Among the latter, there are two types:

1. Those that are faring badly.
2. Those that might soar but could just as easily plummet.

In these turbulent times, only a miracle could help the first type succeed. The second type, however, has every chance of not only surviving but thriving. This makes it critical for them to make the right strategic decisions now.

At this crucial juncture, the views of venture capital market leaders, mentors and experts carry greater weight, and many of them have publicly and unequivocally advised founders to lengthen their project’s runway and push it into the black. A significant number of companies have enthusiastically embraced this idea, but the sad truth is that, this is probably the worst possible advice for most startups right now.

One of the most interesting companies in our portfolio almost fell victim to this advice. A mentor advised the founder to lengthen their runway as much as possible. We looked at how they would have accomplished this and discovered that the proposed cost-saving measures would have practically destroyed growth. At that point, the project would have not been of interest to anyone. Why?

The answer is simple and stems from the nature of the venture capital market. In its early stages, a promising IT business might earn little but will be valued at 10 times its annual profits. An investor buys the project for the potential of explosive growth in the hope that the return will be many times the initial investment.

Now imagine what happens to a startup that chooses a belt-tightening strategy at the expense of growth. In practice, this means the company had been spending heavily to maintain a high monthly growth rate of say 20%. But now, the company decides to become profitable at any cost. It slashes spending on growth and revenues fall proportionately. As a result, the company reaches the coveted break-even point at a much slower growth rate. Even worse is the drastic drop in revenue the startup has accepted to hasten the day when it can earn more than it spends.

Whenever this happens, I ask a couple of simple questions: What will happen one year from now? How will investors respond after the company has applied this strategy for 12 months? The founder will likely point out that, despite the difficult times, the company is now profitable, has high margins and very steady growth. But the investors will see before them only an ordinary business that does nothing more than stay afloat. Will this startup raise a new round of investment with its low systematic growth and even less ambition? No, it will not.

Founders tend to like the idea of breaking even as quickly as possible. Although their company might not become a unicorn, it can now earn them a stable salary and dividends. But for an investor, this is terrible. In this model, not only will the investor earn much less than they had hoped, it will also take them years to recoup their investment. The venture market is not about achieving slow, steady growth, and when a startup opts for profits at the expense of its ambitions, the whole point of its existence is moot.

Unfortunately, there is no universal method by which a startup can survive economic turbulence. It’s critical to keep your ambitions in your sights as well as the nature of the struggle in which you are engaged.

Therefore, I advise the companies in our portfolio to:

1. Conduct a review of the business and audit finances and structure. There is always a smart way to trim a little fat. This is a natural process for startups, and there are almost always more resources than needed. An audit can reduce them by 10%-30%, which can prove critical later.
2. Rethink processes such as promotions or supply chain. Refusing to take the beaten path can radically improve a project’s unit economics. It will not only increase the time to the next round, it will also make the project more attractive to investors.
3. Raise more funding. Although you may get a flat round or bring in even less than before, it isn’t a complete loss. Ultimately, more capital can buy the project time and resources that can help boost growth.