Soft landings in venture
2023 was the year we speculated about whether the Fed could pull off a soft landing in the U.S. economy. Throughout 2024, as startups digest and then vomit up a ZIRP-fueled generational investing mania, we'll be wondering which venture-backed companies can do the same.
You know the story. Companies raised insane amounts of money at equally insane valuations, may or may not have stumbled into working business models along the way, and now need to somehow stick the landing in a more "normal" valuation environment. In this context a “soft landing” means either a retreat to profitability (without breaking anything permanently) or a subsequent round of funding that doesn’t permanently annihilate the cap table. “Growing into your valuation” is challenging in normal times but nearly impossible when your last round priced at 100, 200, or 500 times revenues.
“Startups should all be asking themselves one key question today: Have we really built something that has differentiated product market fit and can sustainably exist as a standalone company? Or are we essentially walking dead but on endless life support with our big cash balance?”
Zoom boardrooms around the country are all having the same conversation right now. “What's the best route, given our remaining cash in the bank, to pull this off?” “Would we be better off cutting immediately to break-even and living with 10-20% growth?” “Should we continue to burn but aim to be Rule of 40?” “Would it really be such a disaster if we raised a down round?”
The good news is — to torture this plane metaphor even further — such massive round sizes have provided companies with unusually long runways. There’s a reason we’re having these conversations in summer 2024 instead of fall 2022.
The bad news is that unless you have a credible path to cash profits in the very near future, the mechanics of the venture capital industry may dictate that the only way to stick the landing is by stretching to grow revenues rather than merely shrink costs. This is like (counterintuitively) using your last drops of fuel to accelerate as you descend because moving too slowly will cause the engine to stall. Sometimes the only way out is forward.
I'm certainly not saying that you should continue onwards. Maybe you should cut hard to breakeven or sell the business. Maybe you should wind the thing down and return money to shareholders. I don’t know.
But you should at least note that with sentiment quite grim at the moment and fundraising (outside of AI) as tough as it’s ever been, your instincts may be telling you to freak the f— out and do something about this now. Which *might* create the conditions for over-correction and panic.
There’s a fine line between “taking a cold hard look in the mirror” and being such a pessimist that you give up without even trying. Maybe you can get to safety with your remaining cash on hand (or a modest top-up from your existing investors). Maybe you can do it without laying off half your employees. Have you run the numbers? Do you know whether this moment calls for decisive action, or a cool head & a dose of creativity?
Some tools
Below are a few concepts which have proven helpful in the kinds of discussions we’ve been having with portfolio companies in these circumstances. They don’t necessarily provide answers but they do illuminate paths.
Model everything out. Base case; aggressive case; conservative case. Examine just how dire the situation would be if you kept growing revenues and costs at the rate you are now. Is it super scary and unreasonable? Or do you just need a tiny amount of capital to make it through? Is everyone fixated on raising a huge growth round when merely a small insider bridge would do the trick?
When in doubt, push ARR / FTE upwards. ARR per FTE is an efficiency metric that you can actually manage by. Your path to safety will likely involve flexing the operational leverage that is inherent in your (technology) business. An operating model that steers ARR per FTE upwards every quarter can result in a dramatically improved business by the end of a year. Not only is this an inherently good thing but it also looks very impressive to downstream investors, particularly when interest rates are elevated.
What you burn in a year might be less important than the *rate* at which you’re burning at the *end* of the year. Imagine two different companies burning $20m in a year to add $12m in revenues:
Company A: Burns $5m each of the 4 quarters in the fiscal year.
Company B: Burns $8m in Q1, $6m in Q2, $4m in Q3, $2m in Q4.
These two companies have the same annual burn multiple (1.67), but radically different exiting burn profiles. Company A will need to find capital quickly and appears to be adding costs as fast as it adds revenues. But Company B is a hop skip & jump away from cash break-even even though it was burning way more at the start of the year. Company B will be far easier to finance, with a wider variety of options available to do so, than Company A. The key thing to focus on is not “what can we accomplish over the year?” but what kind of company will we have at the end of the year and what can we do with that business?
Don’t underestimate the headcount freeze. Sometimes we get locked into one of two modes during a crisis: Either we’re doing a big layoff (with all of the bad juju that comes with that), or we’re continuing to invest in more heads in sales & marketing to grow our way through it. But companies can accomplish amazing things just be determining to hold headcount flat for the foreseeable future (which of course drives up ARR / FTE and creates a situation not unlike Company B). I work with one growth stage business that recently grew over +150% over 18 months while not adding any net heads. Every efficiency metric went from mediocre to terrific and its prospects for a soft landing look great. You can’t do this forever because eventually things will start to break. But you probably do it for long enough to survive.
Don’t dismiss debt. Drawing on debt has some serious downsides and should be viewed with great care and suspicion. That said, many companies already have un-drawn debt facilities in place which they are doing everything in their power to avoid tapping because someone told them it’s “too dangerous.” Well, is it? What if your modeling told you that you just needed a few million dollars to achieve the soft landing… should you spend 6 months trying to raise that from equity investors, or could you just have an open-minded conversation with your lender?
Get aligned with your board. One of the most important variables here is what your board needs to see in your business. What are their incentives and desires? Are they driven by the valuation mark, or dilution? Will they fund you and under what conditions? Do they want to the growth story to proceed for many more years, or would they prefer the company be sold soon if possible? Have these conversations EARLY and OFTEN. You don’t have to like what they have to say, but it helps immensely to know where they stand.
Be open-minded on fundraising. Your next round doesn’t have to be “a true Series C.” Maybe the money should come from a strategic even though hundreds of separate VC bloggers have told you not to do that. You may have to round up a bizarre party round of ultra high net worth eccentric weirdos, Kurdish sovereign wealth funds, and the comedian Carrot Top. Who knows. But try not to let the “perfect” be the enemy of the “good enough.” The goal here is to live to see another day.
As always…. good luck.