According to many experts we are in a market in which it is a little bit more complicated to raise capital for startups. As I describe in my book, The Art of Startup Fundraising, the investor mindset has shifted from hyper growth to profitability. Now it all comes down to how you are able to make your first dollar as opposed to capturing a ton of users first without having a clear monetization strategy.
In addition, there have been recent events that have triggered investors to be more cautious. Some of these events include what happened with Theranos or Zenefits, in which investors believed on the growth that founders were promising during fundraising efforts without really doing much due diligence on the technology side or the internal processes used by the company‘s management to scale faster. Read about their stories here and here.
I was very happy when I came across a presentation from Doug Leone at Sequoia Capital where he advises his CEOs on how to overcome a down market. From my opinion this post and his presentation should be taken into consideration not only if you are in a down market but also in the event your company has 6 months left of cash in the bank.
To provide some background, Doug Leone is a legend in Silicon Valley. With a personal net worth of $2.6B, according to Forbes, Leone has invested in some of the most successful companies which include Google, Youtube, Zappos, and LinkedIn.
From my perspective as well, Leone‘s firm is the VC that would make any entrepreneur‘s dream cap table. To give you an idea on how successful this firm is, Sequoia’s partners hear 200 or more pitches a month, while typically funding only two. One story published by Forbes that caught my attention was Leone‘s meeting with Tony Zingale. During this meeting, Leone grabbed Zingale’s resume, flipped it across the desk and snarled: “What do you know about running a startup?” After hearing what Zingale had to say Leone stated: “Okay, now we know you are a smart m-effer. Now we can have the meeting.”
Before diving into the presentation from Doug Leone, I would encourage you to review Sequoia‘s pitch deck template which I cover in detail in my post Study Reveals The Pitch Deck That Will Land You Millions. If you have not done so already you can download my free pitch deck template below.
ACCESS FREE PITCH DECK TEMPLATE
ACCESS FREE PITCH DECK TEMPLATE
In addition, If you want clarity with your fundraising efforts and a defined roadmap to getting the financing you need, instead of continuing in foggy circles of overwhelm, I would encourage you to sign up for the Fundraising Certification which is a 3 week comprehensive course where you would learn everything related to fundraising.
WHERE DO WE GO FROM HERE?
This was a presentation that Doug Leone and his partners gave at a Sequoia Capital All-Hands Meeting on Sand Hill Road. There were about 100 CEO’s in attendance.
Some of the key advice during this meeting according to Brian Combs was:
- Raising capital is nearly impossible if you’re too far off of cash flow positive
- Getting another round if you’re not profitable will be rough.
- Manage what you can control. You can’t control the economy, but you can control everything else.
- Don’t trust your models and spreadsheets. All assumptions prior to today are wrong.
- Focus on quality.
- Reduce risk.
- Nail your Sales and Marketing message.
- Pound your competitors shortcomings.
- Aggressive PR and Communications strategy is key.
- You must have a proven product
- Your product should reduce expenses and drive revenue
- Honestly assess your solution vs. your competitors.
- Cash is king [have you gotten this message yet?]
- You must get to profitability as soon as possible to weather this storm and be self-sustaining.
UPS AND DOWNS ALWAYS OCCUR
There is no doubt that just like this slide states there will be times where it will be easier to raise financing than others. As I have stated above it is not as easy for an early stage startup to raise capital today in comparison with how investors would throw money at entrepreneurs a few years ago.
From my own perspective, as an entrepreneur you should always treat the capital that you raise as if it was your own and never take it for granted. When you are raising capital not only cover 18 to 24 months of runaway, but do so without taking into account potential revenues leaving yourself some room for unexpected operational costs.
IT IS DIFFERENT THIS TIME
I like the way Leone treats this down market as a different animal. I am a believer of the idea that every event is different. As an entrepreneur you should always plan for the worst and expect the best no matter the situation that you have ahead of you.
RECOVERY WILL BE LONG
It is always very hard to understand how the recovery will unfold. However, entrepreneurs should understand that times change and the way you raise money and your strategy also needs to change. For example, a Series A back in 2005 would be around $5M or so. Nowadays, Venture Capital firms like Sequoia or Accel are investing at Series A rounds of $10M and up which could have been a Series B back in 2005.
For that reason, the change in the investor mindset is real this time around. The hyper growth mentality has burnt along the way founders as well as investors and there is a correction in which the due diligence and the level of expectations to raise a financing round have gone much higher than where they used to be. A few years ago you could have significant user growth month over month or a top tier investor onboard. These factors would convince other investors to join. However that is not the case at this point in time.
Take as an example the app Secret. The company raised up to $25M from investors such as Index Ventures, Redpoint Ventures, Garry Tan and Alexis Ohanian, SV Angel, Fuel Capital, or Ceyuan Ventures. Normally VC firms are like sheeps. They tempt to follow one another. Like in the case of Secret, if you were able to get one big name onboard then a lot of other firms would join right after without performing much diligence on the opportunity out of fear of missing out on the deal.
Examples like the above are not going to happen as often as they used to before as institutional investors have received some backlash from their limited partners which are the investors that finance VCs.
CHANGES IN FINANCING ENVIRONMENT
As an entrepreneur you need to be able to do your own analysis on everything that you read on the press. Sometimes reporters just want to sell with catchy headlines. However, when you are starting to see a trend where there is not just one journalist pointing out to something that should make you wonder.
With that being said, make your own judgment and strategize with your management team to navigate with a masterful execution whatever storm you have ahead of you. Whatever choices you make will either make or break your business.
When you are in a good market everything is wonderful. You see this on how startups burn through cash in some of the most stupid stuff that is completely unrelated to the success of the business. Some of this expenses don‘t really contribute or impact the bottom line.
Some of the crazy perks that I have heard include catered meals, in-office massages, free afternoon yoga classes… Emilie Bonnie published on Wrike a good summary on some of the craziest startup perks:
As you would agree with me probably all these type of expenses could be avoided and when you are in a down market you need to cut from everywhere you can. The first thing should always be perks that are not strictly attached to revenues.
As Leone points out there is nothing like accelerating becoming cash flow positive ASAP. You want to get to a point in which you don‘t need to rely anymore in additional financing to survive. When you are at the profitable status you have more leverage and it is much easier to raise capital on your own terms instead of raising capital out of desperation which would either put you out of business or push you to take on a massive dilution. Investors can smell desperation from a mile away and believe me that for them it is an absolute turn off.
This slide is very obvious. When you are in a not so favorable market there is much less cash to throw around and as a result large corporations will slow down their M&A. Prices would decrease and the companies that are doing well will go out to the market on rebates and acquire companies for a fraction of the price tag they once had.
However, there are exceptions. I like how Paypal for example strategized towards a down market when they sold back in 2002 to eBay for $1.5B. The founder Peter Thiel played the cards very nicely. He knew there was a down market coming his way. He decided to raise additional capital to extend the runway and the rest is history. While many companies were going out of business Paypal made a record sale.
Moreover, IPOs are the new down rounds. Startups are trying to avoid going public for as long as they can. The main reason for this is due to the reporting and to the fact that when you go public you are exposing yourself completely to the market. There are a good amount of private companies that are raising capital on hype but when the moment comes to file for an S1 form to go public that is the moment when you see who is for real. For that reason less IPOs are happening because companies are not ready to take it to such level.
Having a product is the first rule of thumb for any company to have a chance at surviving. From my perspective if you don‘t have a product in the market where you are generating some historical data you should NOT be raising any financing at all. You are in the business to serve your customers and not to raise capital. Founders get this wrong most of the time and when they realize it is too late. Remember that you are raising capital to speed up the machine and not to build it.
Just like Leone points out, you need to have a revenue model that scales and that it is proven. Have distribution channels that are able to create sustainable revenue streams where you are able to project how the next couple of years would look like which is the story that ultimately will be shared to onboard new investors and to keep top talent in the company. They will only join you or stay in the event they see a future for themselves.
Customer adoption of your product is critical. You should be grounded enough to understand what customers like about your product and what they dislike. Survey as many as you can of your customers to understand what is that one thing that you are missing. This will help you to cover holes much quickly and as a result you will scale faster.
Study your paying subscribers and see what are their behaviors to optimize conversion. See if there are any barriers or hurdles that avoid your customers from pulling their credit card out to pay you. Try to make the funnels as simple as possible to reduce the amount of friction. Take as an example eBay vs. Amazon. Amazon won the battle as it took one simple click to check out and make the payment while on eBay it took three clicks to pay. Something of this nature might seam like a small deal but it really can have a significant impact on your business and future revenues.
Analyze your competition. What are they doing better than you? What kind of correction can you put in place? How can you execute much faster than them? What competitive advantage can you bring on that would set yourself apart? Some questions to think about.
Lastly cash is king. All that capital that you are burning through will never come back. For that reason you need to really focus on increasing revenues in order to avoid cash burn.
From an operations perspective, according to Brian Combs, during the all hands meeting of Sequoia Capital it was stated the following during the presentation:
- Engineering: Since you already have a product, strongly consider reducing the number of engineers that you have.
- Product: What features are absolutely essential? Choose carefully and focus.
- Sales & Business Development: What is your return on this investment? The Valley has gotten fat
- Sales people: Big bases, big variables. Cut base salaries on sales people, highly leverage them with upside (increase variable) and make people pay for themselves via increased sales productivity. Don’t add sales people until you’ve achieved your goals with sales productivity. Be disciplined.
- Pipeline: Scrub and be honest with yourself.
Ultimately it comes down to cutting fat from everywhere you can. You should let go every single individual that is not strictly attached to revenues. Your biggest cost will most likely be payroll and for that reason you want to keep the head count minimal.
Try to look around you and within your financials. Which items are necessary and which ones are nice to have? Ask yourself that question and let go of every single item that falls into the category of the nice to have.
At this point you have conducted multiple tests on the sales side as well as on the business development side. You know what has been working and what has not been working so well. Cut all the initiatives that have not brought in great results and double down on the initiatives that are proven to work. Have your sales team with goals and hold them accountable to them.
If the founders or management team have high salaries I would recommend, just like Leone suggests, a deferred plan for those salaries. Perhaps an agreement in which these salaries are repaid as soon as your next financing round is closed and in the bank.
The last item that I‘d like to point out to in this slide is the pipeline. Out of all the conversations that your team is having focus on the low hanging fruits first. Try to bring that revenue in to continue reducing burn and prioritize from more likely to less likely to close.
The death spiral is one of the worst paths to embark when you are executing with your venture. Some of the signs that will tell you that you are heading in the wrong direction as stated in a Quora post include:
- Your team seems to be working incredibly hard, but no tangible progress is being made
- You find yourself watering down the reality when presenting to your board
- Back-channel discussions among frustrated employees
- Aborted projects, ineffective meetings, land-mines
- Unnatural focus on process (e.g. new tools obsession)
- Your best employees appear to be checking out
- Vanity metrics
- Scapegoating a particular department
SURVIVAL OF THE QUICKEST
It is critical to do the cost cutting ASAP. The graph on the slide above can give you the picture on how things look like when you implement corrections right away. At the beginning there will be a significant drop on your results and progress compared to those companies that just keep going as it is.
While you may experience a drop at the beginning you will end up the recovering later on. Not the same picture for Company A. The company seams to be performing on this graph great as it continues to increase the progress over time. However, at some point there is a drop and everything starts to crumble until the company goes out of business as a result of poor management and lack of anticipation.
What this graph comes to show is how critical strategy and planning ahead is. My recommendation is that instead of going out for funding 6 months before running out of cash you start building relationships and having casual conversations much earlier. Perhaps when you have 8 or 9 months of runway left.
Part of the strategy that I teach on the Fundraising Certification course, where as I teach entrepreneurs everything they need to know about fundraising, is not to disclose that you are in fundraising mode until you have a lead investor during your fundraising conversations.
Remember that as an entrepreneur you are fundraising 24/7 but the investor doesn’t need to know that. As soon as you have a lead investor that puts on a price tag on your equity offering, then establish a deadline for everyone else that you have spoken with before to either get in or to miss their ticket. This will create a great sense of urgency that will help you in closing the financing.
NO ONE MOVES FAST ENOUGH
Obviously this slide shows how large corporations struggle to apply corrections. However, early stage companies have the advantage of being able to move much faster. For that reason I don‘t want to spend much time on this slide. In any case, this should serve as a good reference for you.
My suggestion is to keep an eye out on your industry and see what are the trends and how are investors behaving towards your competitors. Things like the amounts they are raising and the valuations at which they are raising should give you some guidance in terms of what the market is ready to pay.
In the event you see that valuations are low perhaps you should raise under the terms of a convertible note to extend your runway and to avoid a down round with massive dilution. In the event you are able to hit significant milestones with the convertible notes capital then whenever you are ready to do the next equity round the valuation that you would be achieving would be much higher.
Life and business are all about choices. These choices will impact for the good or for the bad the future that is ahead of you. For that reason on this slide I found interesting to mention Morley’s book, The Man in the Mirror. He has suggested some tips for making better decisions which are the following:
- Don’t solve the wrong problem.
- Choose with care from decisions given by others.
- Balance the pros and cons of the choices.
- Define the problem.
- Define the goal or objective to be achieved.
- Develop a range of alternative solutions.
- Develop a contingency plan.
- Know the consequences and the trade-offs of each alternative.
- Listen better
If I had to choose one of the above that would definitely be listening better. You should be mastering the art of listening with your employees, your customers, and investors. If you want to grow much faster and cover the holes quicker set some time every week to speak with your customers to see what you are missing. This is something that Jeff Bezos from Amazon mastered. Especially listen to the angry customers as you will be able to learn the most from them.
EMAIL FROM DOUG LEONE
I like the reaction of Doug Leone here. The way he prepares his portfolio companies to plan for the worst and to expect for the best. During tough markets you will need to start building relationships much sooner and be more realistic about potential outcomes.
I was very shocked at the beginning this year when I saw Venture Capital firms raising funds left and right while companies were having troubles to close their next round of financing. I was able to understand the reason why after giving it further thought and this slide confirms it.
Basically when the market is rough VCs are able to have the leverage as valuations of the companies are much lower. Especially of those companies that have been able to grow very quickly their user base without a clear strategy to monetize the user.
What this comes to show once again is that regardless of where the market is always shoot for profitability as soon as you can. That would always give you a position of leverage towards VCs and perhaps towards large corporations that are looking at your company as a target for an M&A transaction.
This slide is just a nice summary of everything we have talked about above. My favorite part of it is where Leone points out sales structures. You want to make sure that your sales people are performing and not only that. They should be motivated by a fair structure that in the event is achieved could be a winning scenario for you as well as the employee. Try to keep the base low and the commissions high.
During this period where you are adapting and listening to everything around you, avoid salary increases and everything else that may increase your monthly costs. Understand the fail fast mentality that some Venture Capitalists on your board may have, but you should be taking calculated risks. Do not throw yourself out of the cliff without having a parachute in your back pack.
GET REAL OR GO HOME
If you are able to listen and to perform your analysis I have no doubt that you will overcome whatever comes your way. Remember that life as well as business are a sequence of events and what matters is how we react towards them. For that reason don‘t be afraid of making difficult decisions. While they may not be fun to make and laying people off is tough, you are looking to save your boat from sinking and you need to do whatever it takes to get your ship to port.
Furthermore, and as a bonus, another legend in Silicon Valley that also provided some direction to its portfolio companies in a down market was Ron Conway. Conway was an early stage investor in Google, Ask Jeeves and PayPal. Given the topic I thought it would be interesting to post the emails that he sent out giving some tips and direction to his entrepreneurs in order to navigate a down market. These emails were published by TechCrunch.
——— Forwarded message ———-
From: Ron Conway
Date: Tue, Oct 7, 2008 at 12:12 PM
Subject: IMPORTANT PLEASE READ ASAP …..REGARDING CURRENT MARKET CONDITIONS…Confidential
We have all been absorbed by the turmoil in the financial markets the past few weeks
Unlike the turmoil of 2000 when the “action” was centered right here in Silicon Valley this time is it centered on Wall Street…..but it has rippled to the west coast quickly and we will not be “immune” to its drastic effects.
I was an active investor in 2000 when the “bubble burst” and remember it vividly and want to give you the SAME EXACT advice I gave to my portfolio company CEOs back then.
I have pasted in the emails I sent on April 17th 2000 and May 10th 2000 and every word applies today.
Unfortunately history DOES repeat itself but I hope we can learn from history and prevent the turmoil from occurring again.
The message is simple. Raising capital will be much more difficult now.
You should lower your “burn rate” to raise at least 3-6 months or more of funding via cost reductions, even if it means staff reductions and reduced marketing and G&A expenses. This is the equivalent to “raising an internal round” through cost reductions to buy you more time until you need to raise money again; hopefully when fund raising is more feasible. Letting go of staff is hard and often gut wrenching. A re-evaluation of timelines and re-focus on milestones with the eye of doing more with less will allow you to live many more days, and the name of the game in this environment in some
respects is survival–survival until conditions change.
If you are in a funding cycle, you should raise your funding as soon as possible and raise as much as possible but face the fact that if you can’t raise money now you must cut costs.
While I do not own a large percentage of your company I hope you will consider this thoughtful advice.
I was here in 2000 and want to share what I learned through many years of experience and historical “pattern recognition”!
Here are the two emails from the year 2000 that I referred to above and all the statements apply in today’s market:
To: Angel Investors, L.P. Portfolio CEOs
Date: 04/17/2000 05:24 PM
From: Ron Conway
RE: Market Conditions Effect on Angel Investors, L.P. Portfolio
The down draft in the stock market sends us some obvious “signals” and we can’t help but mention them.
1. If you are in a funding cycle, you should raise your funding as soon as possible and raise as much as possible.
2. Many companies are ignoring certain VC leads we’ve provided in order to concentrate on the top tier only. While we have preached that in the past, this is no longer the case. Currently, top-tier VC
bandwidth constraints, coupled with the market down draft, make it very important to take meetings with any VCs where you can get their attention. We have been working hard to open up this new bandwidth.
3. You must aggressively examine and pursue M&A opportunities (unless you have over 12 months of cash reserves!) ro insure you have critical mass (including funding, customers, rolodex power, market
share, cash, synergy, etc.).
4. Be realistic on valuations – they will fall so be ready and willing to co-operate.
5. Look for corporate partners to invest so you can raise more money. You should also consider a sale of your company to your corporate partners.
6. If you are entering a funding cycle start raising money sooner rather than later.
7. While it’s safe to say entrepreneurs have had negotiating leverage with the “down draft” in the market, the VC community will start exercising their leverage.
To: Angel Investors, L.P. Portfolio CEOs
Date: 05/10/2000 05:23 PM
From: Ron Conway
RE: Market Conditions Effect on Angel Investors, L.P. Portfolio
I want to “touch base” again; given the continued uncertainty in the capital markets.
As the market turmoil continues, we must underscore the advice that we have provided since mid April and it boils down to just a few points:
1) The capital market window is shut, including IPOs and VC Funding (VCs are looking at their existing portfolio funding needs – not new opportunities). Basically the market is now looking for PtoP (Path to Profitability) instead of BtoC, BtoB, etc! PtoE will prevail price to sales ratios! You must lower your “burn rate” to raise at least 3-6 months more of funding via cost reductions, even if it means selective staff reductions and reduced marketing and G&A expenses. This is the equivalent to ‘raising
an internal round” through cost reductions to buy you more time until you need to raise money again; hopefully when fund raising is more feasible.
2) If you have $10M or less in the bank you must do #1 above plus look at M&A options for your company; especially if your company is BtoC, content, advertising model, community, commerce, and even BtoB. An M&A transaction will allow you to gain critical mass and to get two sets of funding sources and rolodexes working on your behalf. M&A transactions take over 90 days so you need at least that much cash to fund your company. You must attend our M&A day on May 24th at the San Mateo Marriott at 3:00 PM. We will have investment banks there in addition to entrepreneurs who have
successfully accomplished M&A transactions. We will send you details.
We are still developing many new funding sources for our portfolio companies that are in funding cycle.