October 2015
When I talk to a startup that's been operating for more than 8 or 9 months, the first thing I want to know is almost always the same.
Assuming their expenses remain constant and their revenue growth is what it has been over the last several months, do they make it to profitability on the money they have left?
Or to put it more dramatically, by default do they live or die?
The startling thing is how often the founders themselves don't know.
Half the founders I talk to don't know whether they're default alive or default dead.
When I talk to a startup more than 8 or 9 months old, my first question is almost always: at constant expenses and current growth, do they reach profitability on the money they have left? By default, do they live or die?
The startling thing is how often the founders themselves don't know. Half don't.
When I talk to a startup more than 8 or 9 months old, my first question is almost always whether, at its current burn and growth, it reaches profitability on the money it has left. By default, does it live or die?
The reason I want to know first whether a startup is default alive or default dead is that the rest of the conversation depends on the answer.
If the company is default alive, we can talk about ambitious new things they could do.
If it's default dead, we probably need to talk about how to save it.
We know the current trajectory ends badly.
How can they get off that trajectory?
Why do so few founders know whether they're default alive or default dead?
Mainly, I think, because they're not used to asking that.
It's not a question that makes sense to ask early on, any more than it makes sense to ask a 3 year old how he plans to support himself.
But as the company grows older, the question switches from meaningless to critical.
That kind of switch often takes people by surprise.
I ask first because the rest of the conversation depends on it: default alive, we talk about ambitious new things; default dead, how to save it.
Why do so few founders know? They're not used to asking — early on the question makes as little sense as asking a 3 year old how he'll support himself. But as the company ages it switches from meaningless to critical, a switch that surprises people.
I ask first because the rest of the conversation depends on it: default alive means ambitious plans, default dead means rescue. Founders miss it because the question switches from meaningless to critical as the company ages.
I propose the following solution: instead of starting to ask too late whether you're default alive or default dead, start asking too early.
It's hard to say precisely when the question switches polarity.
But it's probably not that dangerous to start worrying too early that you're default dead, whereas it's very dangerous to start worrying too late.
The reason is a phenomenon I wrote about earlier: the fatal pinch [blocked].
The fatal pinch is default dead + slow growth + not enough time to fix it.
And the way founders end up in it is by not realizing that's where they're headed.
My solution: instead of asking too late, start asking too early. Worrying too early that you're default dead isn't that dangerous; worrying too late is.
The danger is the fatal pinch [blocked] — default dead plus slow growth plus no time to fix it — which founders reach by not realizing it.
My fix: instead of asking too late, start asking too early. Worrying too soon that you're default dead is rarely dangerous; worrying too late risks the fatal pinch — default dead plus slow growth plus no time to fix it.
There is another reason founders don't ask themselves whether they're default alive or default dead: they assume it will be easy to raise more money.
But that assumption is often false, and worse still, the more you depend on it, the falser it becomes.
Maybe it will help to separate facts from hopes.
Instead of thinking of the future with vague optimism, explicitly separate the components.
Say "We're default dead, but we're counting on investors to save us."
Maybe as you say that, it will set off the same alarms in your head that it does in mine.
And if you set off the alarms sufficiently early, you may be able to avoid the fatal pinch.
It would be safe to be default dead if you could count on investors saving you.
As a rule their interest is a function of growth.
If you have steep revenue growth, say over 5x a year, you can start to count on investors being interested even if you're not profitable. [1] But investors are so fickle that you can never do more than start to count on them.
Sometimes something about your business will spook investors even if your growth is great.
So no matter how good your growth is, you can never safely treat fundraising as more than a plan A. You should always have a plan B as well: you should know (as in write down) precisely what you'll need to do to survive if you can't raise more money, and precisely when you'll have to switch to plan B if plan A isn't working.
Founders also skip the question by assuming it'll be easy to raise more. But that assumption is often false — and the more you depend on it, the falser it becomes.
It helps to separate facts from hopes. Saying "We're default dead, but we're counting on investors to save us" may set off the same alarms in your head that it does in mine.
Investors' interest is a function of growth, but they're so fickle you can only start to count on them. So treat fundraising as a plan A only, and always have a written plan B.
Founders also skip the question because they assume raising more will be easy — an assumption that gets falser the more you lean on it. Investors can be a plan A, never more; always have a written plan B for surviving without them.
In any case, growing fast versus operating cheaply is far from the sharp dichotomy many founders assume it to be.
In practice there is surprisingly little connection between how much a startup spends and how fast it grows.
When a startup grows fast, it's usually because the product hits a nerve, in the sense of hitting some big need straight on.
When a startup spends a lot, it's usually because the product is expensive to develop or sell, or simply because they're wasteful.
Growing fast versus operating cheaply isn't the sharp dichotomy founders assume; there's little connection between spending and growth. Fast growth means the product hit a nerve; heavy spending means it's expensive to build or sell.
Growing fast versus operating cheaply isn't the sharp dichotomy founders assume. Fast growth usually means the product hit a real need; heavy spending usually means it's expensive to build or sell, or the team is wasteful.
If you're paying attention, you'll be asking at this point not just how to avoid the fatal pinch, but how to avoid being default dead.
That one is easy: don't hire too fast. Hiring too fast is by far the biggest killer of startups that raise money. [2]
Founders tell themselves they need to hire in order to grow.
But most err on the side of overestimating this need rather than underestimating it.
Why?
Partly because there's so much work to do.
Naive founders think that if they can just hire enough people, it will all get done.
Partly because successful startups have lots of employees, so it seems like that's what one does in order to be successful.
In fact the large staffs of successful startups are probably more the effect of growth than the cause.
And partly because when founders have slow growth they don't want to face what is usually the real reason: the product is not appealing enough.
Plus founders who've just raised money are often encouraged to overhire by the VCs who funded them.
Kill-or-cure strategies are optimal for VCs because they're protected by the portfolio effect.
VCs want to blow you up, in one sense of the phrase or the other.
But as a founder your incentives are different.
You want above all to survive. [3]
How do you avoid being default dead? Easy: don't hire too fast. Hiring too fast is by far the biggest killer of startups that raise money.
Founders overestimate the need to hire — partly from all the work, partly because successful startups have big staffs (an effect of growth, not its cause), and partly because the real reason for slow growth is unwelcome: a weak product.
Recently-funded founders are also pushed to overhire by their VCs, for whom kill-or-cure strategies are optimal — they want to blow you up, one way or the other. But your incentives differ: you want to survive.
How do you avoid being default dead? Don't hire too fast — it's by far the biggest killer of startups that raise money. Founders overhire from overwork, cargo-culting big staffs, denial about the product, and VCs whose incentives differ from yours.
Here's a common way startups die.
They make something moderately appealing and have decent initial growth.
They raise their first round fairly easily, because the founders seem smart and the idea sounds plausible.
But because the product is only moderately appealing, growth is ok but not great.
The founders convince themselves that hiring a bunch of people is the way to boost growth.
Their investors agree.
But (because the product is only moderately appealing) the growth never comes.
Now they're rapidly running out of runway.
They hope further investment will save them.
But because they have high expenses and slow growth, they're now unappealing to investors.
They're unable to raise more, and the company dies.
Here's a common way startups die. They make something moderately appealing, get decent growth, raise a first round easily. But growth is ok, not great. They convince themselves hiring will boost it; investors agree. It never comes.
Out of runway, they hope investment will save them — but with high expenses and slow growth they're unappealing to investors, can't raise, and die.
A common death: a moderately appealing product gets decent growth and an easy first round, but ok-not-great growth tempts the founders to hire. Growth never comes, runway runs out, and now too expensive and too slow, they can't raise — and die.
What the company should have done is address the fundamental problem: that the product is only moderately appealing.
Hiring people is rarely the way to fix that.
More often than not it makes it harder.
At this early stage, the product needs to evolve more than to be "built out," and that's usually easier with fewer people. [4]
Asking whether you're default alive or default dead may save you from this.
Maybe the alarm bells it sets off will counteract the forces that push you to overhire.
Instead you'll be compelled to seek growth in other ways.
For example, by doing things that don't scale [blocked], or by redesigning the product in the way only founders can.
And for many if not most startups, these paths to growth will be the ones that actually work.
Airbnb waited 4 months after raising money at the end of Y Combinator before they hired their first employee.
In the meantime the founders were terribly overworked.
But they were overworked evolving Airbnb into the astonishingly successful organism it is now.
What they should have done is fix the real problem: the product. Hiring rarely fixes that, and more often makes it harder. Early on a product needs to evolve, which is easier with fewer people.
Asking the question may counteract the forces pushing you to overhire. Instead you'll seek growth by doing things that don't scale [blocked], or redesigning the product as only founders can.
Airbnb waited 4 months after Y Combinator before hiring their first employee. The founders were terribly overworked — but overworked evolving Airbnb into the astonishingly successful organism it is now.
What they should have done is fix the real problem — the product. Hiring rarely fixes that and usually makes it harder; early on a product needs to evolve, which is easier with fewer people. Asking the question pushes you toward real growth, as it did for Airbnb.
Notes
[1] Steep usage growth will also interest investors. Revenue will ultimately be a constant multiple of usage, so x% usage growth predicts x% revenue growth. But in practice investors discount merely predicted revenue, so if you're measuring usage you need a higher growth rate to impress investors.
[2] Startups that don't raise money are saved from hiring too fast because they can't afford to. But that doesn't mean you should avoid raising money in order to avoid this problem, any more than that total abstinence is the only way to avoid becoming an alcoholic.
[3] I would not be surprised if VCs' tendency to push founders to overhire is not even in their own interest. They don't know how many of the companies that get killed by overspending might have done well if they'd survived. My guess is a significant number.
[4] After reading a draft, Sam Altman wrote:
"I think you should make the hiring point more strongly.
I think it's roughly correct to say that YC's most successful companies have never been the fastest to hire, and one of the marks of a great founder is being able to resist this urge."
Paul Buchheit adds:
"A related problem that I see a lot is premature scaling—founders take a small business that isn't really working (bad unit economics, typically) and then scale it up because they want impressive growth numbers.
This is similar to over-hiring in that it makes the business much harder to fix once it's big, plus they are bleeding cash really fast."
Thanks to Sam Altman, Paul Buchheit, Joe Gebbia, Jessica Livingston, and Geoff Ralston for reading drafts of this.
Steep usage growth interests investors too, but they discount predicted revenue, so measuring usage means needing a higher growth rate to impress them.
Startups that don't raise are spared overhiring because they can't afford it — but that's no reason to avoid raising, any more than abstinence is the only cure for alcoholism.
Pushing founders to overhire may not even be in VCs' own interest: they don't know how many companies killed by overspending might otherwise have survived.
Sam Altman: YC's most successful companies have never been the fastest to hire, and a mark of a great founder is resisting this urge.
Paul Buchheit adds premature scaling — scaling up a business that isn't really working for impressive growth numbers, which makes it harder to fix while bleeding cash.
Notes on usage growth as a leading indicator, why money-less startups are spared overhiring, VCs' own interest, and added remarks from Sam Altman and Paul Buchheit on resisting the urge to hire and scale.