December 2014

Many startups go through a point a few months before they die where although they have a significant amount of money in the bank, they're also losing a lot each month, and revenue growth is either nonexistent or mediocre.

The company has, say, 6 months of runway.

Or to put it more brutally, 6 months before they're out of business.

They expect to avoid that by raising more from investors. [1]

That last sentence is the fatal one.

Many startups hit a point months before they die: money in the bank, but losing a lot each month, revenue growth nonexistent or mediocre. Six months of runway — more brutally, six months before they're out of business. They plan to dodge that by raising more.

That last sentence is the fatal one.

A startup has money in the bank but is burning fast with flat revenue — say six months of runway — and plans to survive by raising more. That plan is the fatal one.

There may be nothing founders are so prone to delude themselves about as how interested investors will be in giving them additional funding.

It's hard to convince investors the first time too, but founders expect that.

What bites them the second time is a confluence of three forces:

The company is spending more now than it did the first time it raised money.

Investors have much higher standards for companies that have already raised money.

The company is now starting to read as a failure.

The first time it raised money, it was neither a success nor a failure; it was too early to ask.

Now it's possible to ask that question, and the default answer is failure, because at this point that is the default outcome.

I'm going to call the situation I described in the first paragraph "the fatal pinch." I try to resist coining phrases, but making up a name for this situation may snap founders into realizing when they're in it.

One of the things that makes the fatal pinch so dangerous is that it's self-reinforcing.

Founders overestimate their chances of raising more money, and so are slack about reaching profitability, which further decreases their chances of raising money.

Nothing fools founders more than how interested investors will be in more funding. Three forces bite the second time: they're spending more now; investors hold companies that already raised to higher standards; and the company now reads as a failure. The first time it was too early to ask; now the default answer is failure, because that's the default outcome.

I'll call this "the fatal pinch." A name may snap founders into realizing when they're in it.

And it's self-reinforcing: founders overestimate their chances of raising more, so go slack about profitability, which decreases those chances further.

Founders delude themselves about how eager investors are to fund round two. Three forces bite them, and the situation is self-reinforcing — slack about profitability further kills their odds.

Now that you know about the fatal pinch, how do you avoid it?

Y Combinator tells founders who raise money to act as if it's the last they'll ever get.

Because the self-reinforcing nature of this situation works the other way too: the less you need further investment, the easier it is to get.

What do you do if you're already in the fatal pinch?

The first step is to re-evaluate the probability of raising more money.

I will now, by an amazing feat of clairvoyance, do this for you: the probability is zero. [2]

Three options remain: you can shut down the company, you can increase how much you make, and you can decrease how much you spend.

You should shut down the company if you're certain it will fail no matter what you do.

Then at least you can give back the money you have left, and save yourself however many months you would have spent riding it down.

How to avoid it? Y Combinator tells founders to act as if each raise is the last they'll ever get — because the less you need investment, the easier it is to get.

Already in the pinch? Re-evaluate your odds. By an amazing feat of clairvoyance, I'll do it for you: the probability is zero.

Three options remain: you can shut down the company, increase how much you make, or decrease how much you spend.

Shut down only if you're certain it will fail no matter what — then at least you give back the money left and save the months riding it down.

To avoid the pinch, act as if each raise is your last — needing money less makes it easier to get. If you're already in it, your odds of raising more are zero. Three options remain.

Companies rarely have to fail though.

What I'm really doing here is giving you the option of admitting you've already given up.

If you don't want to shut down the company, that leaves increasing revenues and decreasing expenses.

In most startups, expenses = people, and decreasing expenses = firing people. [3] Deciding to fire people is usually hard, but there's one case in which it shouldn't be: when there are people you already know you should fire but you're in denial about it.

If so, now's the time.

If that makes you profitable, or will enable you to make it to profitability on the money you have left, you've avoided the immediate danger.

Otherwise you have three options: you either have to fire good people, get some or all of the employees to take less salary for a while, or increase revenues.

Getting people to take less salary is a weak solution that will only work when the problem isn't too bad.

If your current trajectory won't quite get you to profitability but you can get over the threshold by cutting salaries a little, you might be able to make the case to everyone for doing it.

Otherwise you're probably just postponing the problem, and that will be obvious to the people whose salaries you're proposing to cut. [4]

Which leaves two options, firing good people and making more money.

While trying to balance them, keep in mind the eventual goal: to be a successful product company in the sense of having a single thing lots of people use.

But companies rarely have to fail. I'm really offering you the option of admitting you've already given up.

Otherwise it's raising revenue and cutting expenses, which mostly means firing people. Hard — except when there are people you already know you should fire but deny it. Now's the time.

If that gets you to profitability, you've dodged the danger. Otherwise: fire good people, cut salaries for a while, or raise revenues.

Cutting salaries is weak and only works when the problem is small. If a little cut clears the threshold, make the case. Otherwise you're just postponing it, and the people you cut will see that.

Which leaves firing good people and making more money. Keep the goal in mind: a product company with a single thing lots of people use.

Companies rarely have to fail. Decreasing expenses means firing — easiest when there are people you already know you should fire. Salary cuts are weak; if they only postpone the problem, everyone will see it.

You should lean more toward firing people if the source of your trouble is overhiring.

If you went out and hired 15 people before you even knew what you were building, you've created a broken company.

You need to figure out what you're building, and it will probably be easier to do that with a handful of people than 15.

Plus those 15 people might not even be the ones you need for whatever you end up building.

So the solution may be to shrink and then figure out what direction to grow in.

After all, you're not doing those 15 people any favors if you fly the company into ground with them aboard.

They'll all lose their jobs eventually, along with all the time they expended on this doomed company.

Whereas if you only have a handful of people, it may be better to focus on trying to make more money.

It may seem facile to suggest a startup make more money, as if that could be done for the asking.

Usually a startup is already trying as hard as it can to sell whatever it sells.

What I'm suggesting here is not so much to try harder to make money but to try to make money in a different way.

For example, if you have only one person selling while the rest are writing code, consider having everyone work on selling.

What good will more code do you when you're out of business?

If you have to write code to close a certain deal, go ahead; that follows from everyone working on selling.

But only work on whatever will get you the most revenue the soonest.

Lean toward firing if your trouble is overhiring. Hire 15 people before you know what you're building and you've made a broken company — easier to figure that out with a handful, who might not even be who you'll need. So shrink, then grow. You do those 15 no favors flying into the ground with them aboard.

With a handful, focus on making money — not by trying harder, but a different way. If one person sells while the rest write code, have everyone sell. What good is more code when you're out of business? Work only on what brings revenue soonest.

Lean toward firing if you overhired — shrink, then figure out what to build. With a small team, lean toward making money in a different way: have everyone sell, and work only on what brings revenue soonest.

Another way to make money differently is to sell different things, and in particular to do more consultingish work.

I say consultingish because there is a long slippery slope from making products to pure consulting, and you don't have to go far down it before you start to offer something really attractive to customers.

Although your product may not be very appealing yet, if you're a startup your programmers will often be way better than the ones your customers have.

Or you may have expertise in some new field they don't understand.

So if you change your sales conversations just a little from "do you want to buy our product?" to "what do you need that you'd pay a lot for?" you may find it's suddenly a lot easier to extract money from customers.

Be ruthlessly mercenary when you start doing this, though.

You're trying to save your company from death here, so make customers pay a lot, quickly.

And to the extent you can, try to avoid the worst pitfalls of consulting.

The ideal thing might be if you built a precisely defined derivative version of your product for the customer, and it was otherwise a straight product sale.

You keep the IP and no billing by the hour.

In the best case, this consultingish work may not be just something you do to survive, but may turn out to be the thing-that-doesn't-scale [blocked] that defines your company.

Don't expect it to be, but as you dive into individual users' needs, keep your eyes open for narrow openings that have wide vistas beyond.

There is usually so much demand for custom work that unless you're really incompetent there has to be some point down the slope of consulting at which you can survive.

But I didn't use the term slippery slope by accident; customers' insatiable demand for custom work will always be pushing you toward the bottom.

So while you'll probably survive, the problem now becomes to survive with the least damage and distraction.

Another way is consultingish work. There's a long slippery slope from products to pure consulting, and you needn't go far before you're offering something attractive — your programmers are often far better than your customers'. Shift from "want to buy our product?" to "what would you pay a lot for?" and money gets easier to extract.

Be ruthlessly mercenary: you're saving your company from death, so make customers pay a lot, quickly. Ideally you build a precisely defined derivative of your product, otherwise a straight sale — you keep the IP, no billing by the hour.

In the best case this becomes the thing-that-doesn't-scale [blocked] that defines your company. Don't expect it, but watch for narrow openings with wide vistas beyond.

Some point down the slope is usually survivable. But slippery is no accident: insatiable demand always pushes you toward the bottom. So you'll survive — but survive with the least damage and distraction.

Selling different things — more consultingish work — taps customers' insatiable demand for custom work. Be ruthlessly mercenary, keep the IP, avoid billing by the hour. There's always some survivable point down the slope.

The good news is, plenty of successful startups have passed through near-death experiences and gone on to flourish.

You just have to realize in time that you're near death.

And if you're in the fatal pinch, you are.

The good news: plenty of successful startups have passed through near-death and gone on to flourish. You just have to realize in time that you're near death. And if you're in the fatal pinch, you are.

Plenty of successful startups have passed through near-death and gone on to flourish. You just have to realize in time that you're near death — and in the fatal pinch, you are.

Notes

[1] There are a handful of companies that can't reasonably expect to make money for the first year or two, because what they're building takes so long. For these companies substitute "progress" for "revenue growth." You're not one of these companies unless your initial investors agreed in advance that you were. And frankly even these companies wish they weren't, because the illiquidity of "progress" puts them at the mercy of investors.

[2] There's a variant of the fatal pinch where your existing investors help you along by promising to invest more. Or rather, where you read them as promising to invest more, while they think they're just mentioning the possibility. The way to solve this problem, if you have 8 months of runway or less, is to try to get the money right now. Then you'll either get the money, in which case (immediate) problem solved, or at least prevent your investors from helping you to remain in denial about your fundraising prospects.

[3] Obviously, if you have significant expenses other than salaries that you can eliminate, do it now.

[4] Unless of course the source of the problem is that you're paying yourselves high salaries. If by cutting the founders' salaries to the minimum you need, you can make it to profitability, you should. But it's a bad sign if you needed to read this to realize that.

A few companies can't expect revenue for a year or two; for them, substitute "progress" — but only if investors agreed in advance, since illiquid progress puts you at their mercy.

In one variant investors "promise" more — or you read a mention as a promise. With 8 months of runway or less, get the money now: problem solved, or you at least stop denying.

Also cut significant non-salary expenses now. And if you're paying yourselves high salaries, cut founders' pay to the minimum — a bad sign if you needed reminding.

Some companies sell "progress" not revenue, but that puts them at investors' mercy. If investors hint at more money, get it now. Cut non-salary costs and your own high salaries first.

Thanks to Sam Altman, Paul Buchheit, Jessica Livingston, and Geoff Ralston for reading drafts of this.

Thanks to Sam Altman, Paul Buchheit, Jessica Livingston, and Geoff Ralston for reading drafts of this.

With thanks to Sam Altman, Paul Buchheit, Jessica Livingston, and Geoff Ralston for reading drafts.