There’s been a lot in the news about market fluctuations. But here are four key takeaways as they relate to startup funding:
The business will need pristine metrics. Core growth metrics must be pristine to reach the threshold needed to raise capital. “There’s no more overinvesting in growth for the sake of adding to the top line; you have to make the unit economics scale—better than your cohort of peers,” says James Orsillo, Operating Partner at Underscore VC.
It will take longer to raise. “You should expect fundraising to take two, three, or four times longer than it would’ve taken over the last couple of years. And the cost of capital will be prohibitively high,” says Patrick Grady, CEO of TetraScience.
Your funding round may be less competitive. Before, the threshold for rounds was much lower. “There was a ton of competition from investors, but that competition will go away,” says James. “You’ll get half the number of term sheets, and the valuations will be lower.”
Startups will need to grow into their valuations. Because valuations will be lower for future rounds, startups need to “grow into their valuations,” says James. “And to do that, you’ll need more time.”
“How depressing,” says Chris Gardner, Partner at Underscore VC. And while there could be more focus on the opportunities that a downturn can create for entrepreneurs, “There’s no doubt that preserving cash is solid advice,” he says.
“In short, you have to do more with less,” says Michelle Hipwood, CFO of Mable. Here’s how.
Balance Your Priorities
To maintain lean operations, you must be diligent about how and what you prioritize. For each opportunity, ask:
- Will this move the needle?
- Is there an ROI on this?
- Is this a core need?
- Will this generate more revenue?
But there’s an added layer of nuance depending on whether you’re pre- or post-product market fit (PMF).
Pre-PMF: Focus on Learning
When you’re still learning about your product, you have to find a way to balance operational diligence with experimentation. “Figure out what you need to do to move the needle—even if the product still has lots of things that need to be fixed,” says Michelle.
Sometimes that might mean prioritizing a core product need, and sometimes that’s prioritizing revenue. “It’s a balance, and you must ensure that everyone’s on the same page,” says Michelle.
Either way, “Do not take your eye off the PMF ball,” says Patrick. “The nanosecond you get to demonstrable PMF, take a step back and begin to build up a bottom-up plan.”
Post-PMF: Balance Planning and Growth
On the flip side, once you reach PMF, you must balance capital efficiency while investing in growth.
Follow your metrics. “If you’re tracking the right metrics properly, and they’re all green, you may be underinvesting,” says Patrick. “But you’ve got to know where those dollars are going.”
“The beauty of a plan is that every dollar is accounted for,” says Patrick. “Every head is modeled every month in every function with approved compensation bans.”
How to Properly Build Your Plan
The key is getting great at building your plan and hitting your milestones. At TetraScience, every single activity in the organization has to synchronize with the plan of record. “It’s our north star,” says Patrick. This plan comprises three things:
- A strategic plan, which is “immutable once ratified,” says Patrick.
- A financial plan, which outlines how dollars enter and exit the company.
- An operational plan, which outlines the KPIs.
“As you build your plan, be sure to collaborate with the right stakeholders,” says Patrick. “When you open source this process, it removes subjectivity, power politics, nepotism—all the nonsense that tends to plague companies when they scale.”
Lastly, Patrick warns: “Do not build your revenue plan based on what VCs want to see. Use the perfect information you have, not the imperfect information VCs have. Plan for what you believe is your reality. You may not like your numbers, but they are what they are. Then you can respond accordingly.”
Communicate and Hold to Your Plan
“Statistically, most companies fail because they don’t stay focused,” says Michelle. “Once you have your plan, stay laser-focused on it because if you start expanding, you’ll burn through your cash.”
To hold themselves accountable, TetraScience reviews the same questions at every company meeting:
- What was the plan?
- Where are we supposed to be at this point?
- What are the actual results?
- What’s the variance?
- What’s the root cause analysis of this variance?
- What’s our remediation plan?
TetraScience values radical transparency. “Every employee has access to everything I have access to—the cap table, balance sheet, income statement—everything,” says Patrick. The whole company stays aligned and in sync through this system and by communicating openly.
“A lot of founders feel like they’re faking it until they make it,” says Patrick. “They’re afraid that people might run out the door if they tell them the truth. But the reality is that these people are here for a reason; they believe in you and your mission. Share everything you’ve got.”
With all that in mind, the questions below will help you determine which adjustments to make to maintain capital efficiency.
Worksheet: 24 Questions to Ask Yourself
It’s extremely difficult not to get emotional about cost-cutting measures—especially when it involves layoffs. This work is hard. You may need to outline the criteria that will trigger certain cuts. That can help take some of the emotion out of it.
If I don’t reach [goal] by [date], I will need to cut [expense].
Think through the following questions, then adjust your financial model accordingly.
Constraints for Your Customers
- What will change for your customer?
- What is happening to your customer’s customers?
- How will they be impacted financially?
- How will that shift their prioritization of your product/solution?
→ Adjust sales productivity accordingly.
Challenges to Your Growth
- How will these customer constraints impact your sales pipeline?
- What would new bookings look like?
→ Adjust revenue accordingly.
- Would customers stretch out payment terms?
- Which of your customers are at risk of churning?
- How quickly would they churn?
→ Adjust revenue accordingly.
Given these new constraints and customer priorities, how can you re-tool your sales playbook and decrease friction in your sales motion?
- Could you involve key decision makers earlier in the process?
- Can you identify new champions within your target customer?
- Can you adjust your messaging and focus on saving costs?
- How will these changes affect your CAC and sales productivity?
Changes to Your Business Model
Consider benchmarking your financial performance, so you understand your likelihood of raising capital. Look at metrics like ARR growth rate, gross margin, and burn ratio.
- Given all these constraints, what will your unit economics look like?
- Are you a top-quartile business? How will that influence your ability to raise?
- How much cash runway would you have?
- Should you add debt? If you can show a plan with 12 months of cash, this could be an option.
Company Cost Cutting
Consider open-sourcing this exercise to the whole company; share the company spend and financial plan and ask how each team and individual could cut expenses. You may get some creative ideas.
- How can you cut costs so they are right-sized for your slower growth?
- Starting with:
- Discretionary spending: travel, conferences, offsites, etc.
- Software expenses
- Cloud hosting costs
- Can you slow hiring and trim recruiting costs?
- Do you need to cut headcount?
- Can you remove new hires first?
- Will you need to cut existing hires?
Communication and Considerations
- Can you re-do your 409A and think about re-granting options to employees?
- How will you share these changes with your team?
- With your board/investors?
- With other stakeholders?
Pull your learnings from this list of questions, and adjust your financial plan accordingly.