“I am leading or involved in a company… and we are in trouble. What should I do?” In this episode, the beginning of season 3 of Tech Deciphered, we firstly share how to know when you are in trouble (spoiler alert: getting this right is essential) or … if you are “relatively safe”.
- Intro (01:34)
- Section 1: Context (03:28)
- Section 2: How to know the company is in trouble (04:58)
- Section 3: What does “being relatively safe” look like? (17:15)
- Conclusion (28:17)
- Bertrand Schmitt, Entrepreneur in Residence at Red River West, co-founder of App Annie / Data.ai, business angel, advisor to startups and VC funds, @bschmitt
- Nuno Goncalves Pedro, Investor, Managing Partner, Founder at Chamaeleon, @ngpedro
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Nuno G. Pedro
Welcome to season three of Tech Deciphered. We have many surprises in store for the season. But to start, we will have two episodes: Episode 35 and 36, on the topic of My Company is in Trouble. What should I do? In these two episodes, we will discuss context on what is happening currently in the market. But more importantly, we’ll help you figure out if your company is in trouble or not, maybe the most important of the first questions that you should answer.
Secondly, we will talk about what to do if your company is indeed in trouble. And coming from different perspective, not just the perspective of the CEO, but also of people that are involved at the board level or relatively senior people that are involved in the future of the company.
And finally, we come to the “what if all fails” piece, right? If everything’s failed, what should I do? It’s going to be an interesting set of questions, and hopefully, our answers will be helpful to you all.
Section 1 – Context
Thank you, Nuno. Yeah, it would be exciting to start this Episode 35. Maybe to share more context, we can start first with our last two episodes about the bubble bursting, winter coming. I guess winter is getting closer. A lot of great companies, tech companies today, they are valued at 50% of what they were worth last year. Fifty percent, five-zero.
And it’s not just 50%; it’s 50% versus a year ago. Imagine the company attempt to grow, to expand their business, to be more successful, but the market are still valuing it 50% lower. That’s happening for a lot of great companies in tech. If I take some private market, this company in the buy-now-pay-later space that announced pretty recently, [inaudible 00:01:42], that they were moving from $46 billion valuation last year to 6 billion market cap this year for the last round of financing, which is a huge gap. We’re not talking about 50% anymore. We are talking about 90%.
It probably happened because they had to mirror what happened in the public market with other competitors in that space who end up being in a similar situation of losing 90% market cap. Of course, the private market had to react and adjust to that new situation, and you cannot keep disconnecting yourself from the relatives of public markets, especially if you are at very late stage.
Nuno G. Pedro
You have Zoom that was close to 160 billion at the top of it in 2020. Top of COVID, I guess, and now at 25 billion or so. There’s been some interesting… And this is a public company.
We are not talking about Peloton.
Nuno G. Pedro
We’re not talking about Peloton. The whole COVID effect also being felt very strongly in many industries.
Yes, Peloton is actually on 15X.
Nuno G. Pedro
That’s not too bad.
It’s in way more serious financial trouble than some of these companies we are talking about.
Nuno G. Pedro
Today, we will talk about a variety of situations. This question has been asked to us by some of our listeners, which is, okay, now some companies are in actual trouble, and we always have to qualify what does that mean? What does actual trouble mean? A company like Zoom that is worth significantly less than they were during COVID height, I mean, it’s troublesome for Eric and for the leadership team, but honestly, there was a readjustment of their value, and probably now they’re undervalued.
Section 2 – How to know the company is in trouble?
Nuno G. Pedro
It doesn’t mean that Zoom is not a valuable company. If we look at some of readjustments that we saw around companies like Facebook and Amazon and others, these are not companies that are in trouble. They have had readjustments and reset things.
These two episodes will focus a little bit more on actual trouble. Not just valuation trouble but actual trouble. Like what means, may I run out of cash? Do I have a growing business or a growing concern going forward? Maybe let’s start by setting that stage. How do you actually know that your company’s in trouble? Where do you start?
This seems like a really basic question, but it’s often the case that people get it absolutely wrong for a long period of time. That long period of time could be six months or a year, where if I’m the CEO of that company, I could have been working already on a plan to readjust my strategy, my operations, my leadership team, whatever needs to be done to shift the boat into the right direction. And I just missed it.
If there’s anything you want to take away from these two episodes, I would say the first thing to take away is figure out whether your company’s in trouble or not relatively quickly. Listen to your advisors. Listen to your board of directors. Figure out if your actual economics are working or not.
Let’s start with the first thing you can take a look at. Many people in the startup world understand this, but we’re going to explain it in a little bit more detail. Understand your runway. What a runway means is how many months do you have ahead of you with a specific set of assumptions—we’ll discuss that in a second as well—that you can go without running out of cash.
There are many companies that are just fundamentally profitable. They don’t have a concern around that, their unit economic scale, etc., but in any case, many companies are not in that camp. There’s a lot of startups that are burning more cash—we’ll talk about burn in a second— are burning more cash than they’re generating. Therefore, their runway is necessarily limited. It could be 6 months; it could be 12 months; it could be 24 months; it could be something else.
What would they have to do? Just to start this discussion, a runway calculation is actually not that easy because it starts from the perspective of assumptions. In assumptions, you need to think through a variety of things. The first thing you need to think through in your runway calculations is, honestly, if I’m being extremely conservative in terms of my top-line growth, my sales pipeline, but also pretty aggressive in the fact that I might have costs that I’m not fully anticipating. When I do this analysis and I turn it into a cash flow analysis, that will give me probably a very aggressive runway. It’d probably shorten my runway more than I would expect it to do so.
That’s a good thing because that will tell me when do I need more cash infusion, or do I need to do something else about it? Again, if you are in a case today, and we’ll talk about, later on, what is a classic runway. I think in the industry, we talk about 12- to 18-month runways once you raise money. We’ll discuss later that actually, maybe you should extend your runway above the 12- to 18-month period of time, which is classic in fundraising. So I raise so that I can maintain my business going for 12-18 months.
We will talk about it later that we believe that you should actually prolong it. It should be more than 12-18 months. But if I have three months left of runway, we’re running out of cash in three months, and I’m not raising money yet, I’m going to have a problem because raising money takes time—takes 3-6 months; we’ve talked about this in the past—and so, how can I do it? How can I go to that level of maintaining my company growing or going either with financing or with something else?
So I know I’m in trouble if my runway is really, really short, and I have no other way of changing course, or if I need to change course, but I need to change it right now. So first thing to look at, runway. What’s your runway? How many months you have left of cash? Do different scenarios. If you think your scenario is conservative, it’s probably not conservative enough.
Second thing to take a look at is burn. Bertrand, what is burn?
Yes. Maybe before going what is burn, I think it’s very important that the proper scenario is put in place to estimate runway calculation because if you start always using a rosy scenarios that you are going to grow, as expected, nothing more is happening in that market, in that situation, things are going to change; expectations might not be met, and you cannot plan a runway calculation just based on a rosy scenario. You might want to have a downside. You might want to have unexpected, maybe an upside scenario, but you cannot just plan everything on an upside scenario, an optimistic scenario.
To go back to your question, what is burn, burn is simply how much money you are burning every month, so you are losing every month. We are talking typically about cash burn. To be clear, that means that if you are burning, let’s say, one million a month, and you have 10 million in the bank today, and in 10 months from now, you would be out of cash and the runway is 10 months. That’s a very critical metric. Obviously, this one as well would vary depending on your scenario and the assumptions.
Nuno G. Pedro
You mentioned burn as in if you have 10 million in the bank, and I’m burning one million a month, in 10 months, I’ll run out of cash. Obviously, you’re talking about net burn. It’s a difference between the money I’m making and the money I’m spending. When you’re talking to some of your investors, or if you’re on a board of directors, it should be clear sometimes with your CEO asking, is this net burn or is this gross burn? Is this just like how much money are you spending in your…
Do you have at the end of the after the bottom line? How much cash you’re actually burning irrespective of how much cash you’re generating? It’s always an interesting discussion, the same as with runway. It’s like some people have different understandings of what it means and what you put into it. To your point, I think everyone around the table—board members, CXOs, CEO of the company—should have very clear discussion on what means what. If we have a burn discussion systematically, is that the net burn discussion? Is it a gross burn discussion? Runway, what does it actually mean? What are the scenarios around it?
But again, another thing that you really need to pay attention in this case is burn. How much money is the company burning on a monthly basis? Then you have a bunch of other metrics that are very helpful for you to understand the status of your business. That might not be immediate metrics; that might not be immediate indicators for what you’re looking at that give you a very clear view of what’s happening in the future.
A very classic one in particular in B2B businesses is your sales pipeline. How does your sales pipeline look? From top of funnel, to things that are under negotiation, to contracts that have already been allocated to the company that are now coming in to revenue. So you’ve signed a contract, maybe you’ve gotten payments or not. Maybe you’re about to get payments on that contract.
Having all this view is pretty important because if in doubt, if you think the company is actually not doing great, and you’re getting the story of, “Oh, my runway is actually pretty solid. I have 18 months in front of us. We don’t need any cash infusion, just even assuming conservatively where we are.” Some of these elements that we’re just talking about, like a sales pipeline, will immediately give you a cross-check way to look at how healthy your business is.
Because if you look at your sales pipeline, and you come to the conclusion, “Oh, we have our three largest contracts up for renewal, and we don’t know if we’re going to get them or not,” or if you look at your top of funnel sales pipeline and there’s nothing; there’s almost nothing going through your funnel, meaning you have what you have. You don’t know if you’ll continue having it in a few months or not, and there’s nothing else to replenish that cash-generative business, then you’re sort of in trouble as well.
Again, this depends really on the type of business you’re in. There isn’t a one-size-fits-all, “Oh, these are the metrics I need to look at to make sure that my business is working or not.” To figure out if your business is doing well or not, you need to look at the core constituents and metrics of what actually derives growth for your business.
Again, if you’re B2B, SaaS, sales pipeline is very important. You have to understand and actually dig into it. And not smoke dope. Again, you could look at the beautiful sales pipeline—I’m sure Bertrand has seen plenty of those—that looks like the top of funnel is the best top of funnel ever. Probability adjusted, this company is going to triple this year in terms of basic annual contract values or whatever. Then you go under the hood and you start realizing there’s been a lot of incentives created for the sales team that maybe is pushing a lot to top of funnel, but a lot of these things are very unlikely to materialize into projects or into actual sales.
The devil is in the detail. Again, this is not just a discussion for the CEO, where you might be in an organization where you’re basically managing a lot of people and you need to know the truth. This actually is also true for a board of directors with investors on it, where they need to know the truth. They need to know is this really sort of directionally correct, or are we going to run out of cash pretty quickly?
Because what kills companies is not having cash. This happens because people were basically caught napping, either the CEO or some part of the executive team or the board. Someone or several people were caught napping. Nobody paid attention. All of a sudden, the company ran out of cash. Now you could see a company running out of cash months before.
Again, to the point I was making earlier, this question is the most critical question, which is, is my company in trouble or not? It’s a question that systematically needs to be answered. If you’re running a company that has board meetings every three months, and you’re the CEO of that company, it’s still your obligation to figure out every single week if there is something significant that has changed that you need to take into account. If that thing is so big that you need to convey it and have a discussion with the board, that preempts, for example, a board meeting or a board call, your responsibility is there as well.
I’ve seen this over and over again. Like you’re seeing issues too late. It’s like you had a board meeting; everything seemed fine. Three weeks later, the CEO learned something about a contract that they think they were going to win. Doesn’t say anything to the board. The next board meeting is 2-3 months out. When it says it, there’s this board member who’s sheepishly normally raises their hands like, “Sorry, am I missing something? Aren’t you guys now going to have trouble on your topline?”
Normally, pay attention to those questions. The questions of the sheepish board member are normally the most important ones. The guy or the girl that normally raises their hand and says, “Sorry, am I missing something here?” Normally, they’re not. Normally, they saw something that everyone else hasn’t seen and that’s a problem. Again, that’s the type of things in metrics that you need to pay attention to, to really know if you’re in trouble or not.
Yes. On sales pipeline. I think the biggest issue for the younger startups is probably around predictability and making sure that they’re already predict good enough range, the conversion of their sales pipeline to sales. Because even if you have a sales pipeline that looks big, it’s going to solve all of your problems if ultimately, you are not delivering on the sales pipeline, that’s a big issue. Of course, you should try to fix that, but it might take time, change a lot of things. And to big minimum, you should be looking at evaluating your plan, and therefore, your runway based on your ability to monetize your pipeline.
I’ve seen so many situations where some people just tell me flat out for instance that, “Oh, you know what? We know the conversion level that we should reach.” Most companies with these conversion levels. Sure, good luck with that. Once you deliver a track record of historically predicting well enough, then we can try to start to leverage your ratio and look at history and make analogies and take coverage.
But to dare to talk about applying ratios from other companies on the sales pipeline, that’s a very difficult place to be. Or if you do it, you have to assume it’s a different risk. You just cannot come with just an expectation it would be all right based on other company’s ratios.
I think you want to be very careful. And it’s not easy. At some point, as a board, you probably have to either accept the sales pipeline and step by step based on success or lack of success, force some adjustment in the process of the calculation. Or actually relatively quickly, try to go deeper to understand how it’s managed, how it’s calculated, or what are the incentives of the sales team. Some sales team feel that they have to show the highest possible number, even if they believe it’s not doable. It’s a lot of work to get this one right. To be frank, if it was easy to get the sales pipeline right, not a lot of companies would be in trouble.
Section 3 – What does “being relatively safe”, look like?
Nuno G. Pedro
Maybe answering the question of how to know that your company is in trouble, let’s start with the opposite, which is how to know that the company’s relatively safe, the company is okay and there’s no big issue going on. Bertrand had shared with me some thoughts that were shared by other people that we like looking at, like Paul Graham and David Sacks and all that. Maybe you want to share some of the views that these guys have shared recently, the default alive or default dead, and default investible.
It’s like a old saying in Silicon Valley nowadays after 10, 20 years, sometimes more recently. But I think it’s Paul Graham, the founder of Y Combinator who talk about default alive being default dead. Default alive means if you don’t do too much, if you keep it as it is, your company is a going concern. That happens when you are making, obviously, more money, generating more cash than you burn. So that means default alive.
If you have a company that is not generating cash, and the trajectory is not clear, then you are probably in a default dead situation because at some point, if you don’t get additional investment, you are going to die. Once our big markets downturns, anything is possible. Things change. Your current investor might not want to put them on you for some reason. You might have trouble to raise financing.
I actually like the position of David Sacks. A few months ago, we talk about being default investible. That’s kind of in the middle. It might not be as good as default alive. It’s not as bad, certainly, as default dead. It means that you are running your business in such a way that even by relatively prudent metrics with conservative investors, you are running the business in such a way that you should get financing relatively easily, even in a downturn. So relative easy may be a big word, but that you should be able to get financing even in a downturn.
Typically, what is default investible? It means that you are not burning too much. It means that you have some ratio that you are careful to follow. We talk about some, but for instance, one that I like is Burn Multiple ratio. Burn Multiple ratio, it’s net burn. And if you’re a safe business, net burn divided by net new ARR. I guess you can find some variant of this type of ratio for different type of business.
Net burn divided by net new ARR. Basically, it’s how much you are burning in net divided by how much you are bringing in term of new business. How much does it cost you to bring new business in? If this ratio is below one, that’s probably considered amazing. If it’s above three, it’s definitely bad. If you are muddling in the middle, your situation probably depends on financing situation. Or at least the valuation you’re going to get will depend on that. It might not be a binary situation.
Definitely, you want to be less than three, probably less than two these days. Of course, less than one, you have a great ratio. So if you are in that situation, you are default investible. I think good enough situation. But of course, you have to be careful about some exception, like a big sales deal is not happening. You have to be on the lookout for some externalities.
Nuno G. Pedro
Another signal of being relatively safe is your runway. We just talked about what runway meant. In an ideal world, when you just raised around, you’d have a 12- to 18-month runway. During times of crisis, we normally push the companies that we invest in to be a little bit more conservative in their spending, in their plans, to the point where they can probably sustain 24-30 months of runway
Here, we’re talking about almost double the normal runway you would get out of around. What does that mean? There’s a couple of implications on this for you to be relatively safe using this sort of runway metric. One is if you can raise more money, right now, raise it. If that means that extends your runway by 6 months to 12 months, that’s significant because again, you might be then in your 24- to 30-month cycle.
The second piece to take into account and the reason why some of us in the investment world ask for 24-30 months of runway in cases where the company is in the middle of a crisis of some sort or there is a global crisis going on is because we anticipate that fundraising cycles will get more tight. It will be more difficult to raise money. And because we’re extending our runway, what that means is we’re giving ourselves more time to generate more top line, to generate more unit economics—we’ll come back to that—and also to allow us to do what I would call the soft pitching dance.
The soft pitching dance is I’m not really raising money; I haven’t been in the market to raise money in a while, 12 months or 18 months, but if someone, for some reason, sees me and I pop in their radar, an investor, maybe I’ll have the conversation. Maybe I’ll actually raise without needing to raise. This is always an interesting dance. It’s much easier to raise money when you don’t need it—we’ve had this discussion many times in the past—than when you actually do.
If you give yourself more time to raise, if you do it properly, then you actually increase your chances of raising, even though your numbers might not look amazing or not. There’s this notion that you’re relatively safe if you’re runway is in this new margin of, let’s call it, 24-30 months.
The fourth item that one could bring to the table in terms of being relatively safe is unit economics. To the point that Bertrand was making and that Paul Graham has made in the past of default alive, if you’re generating positive unit economics out of everything you deliver, and if it’s a business that may not be fully predictable but has less risk than one would expect, you can have a chance to systematically generate net positive cash flow.
If you’re systematically generating net positive cash flow, if you have clear positive unit economics, so to speak, you are a growing concern, even though you might not be growing very fast. That gives you many options. It gives you the option of doing other things along the way, pushing other types of businesses. But at the very least, it keeps you alive for much longer periods of time. It could be almost infinite. Infinity doesn’t exist quite in the world of tech startups, but it could be almost a world where you could say, “Maybe in the next 4-5 years, I won’t die, for sure.”
Now, that’s not a great aim for you to have. Your investors probably won’t be super excited about that aim, but at least you’re around and you won’t die in the process.
To go back to your point around if you get people proposing new money and you should take it, I definitely double down on that. I’m not sure people fully realize these days that every financing is a risky business. I have seen several situation now where, say, there’s a lot that’s supposed to happen and the financing doesn’t go through. And everyone is running to find an alternative to some things that just bogged down post-LOI, post-signing or in the middle of discussion with investors who are saying all the right things, giving all the right insurance, and finally it doesn’t happen.
You have to be very strict. It’s very unpredictable right now what might be happening with some of your investors, and you don’t want to wait the last minute. So if there is some “easy money” on the table, let’s say you get a proposal from some investors, like last from the financings. They couldn’t get in or they couldn’t put enough money to work, come back to you a year after. They say, “You know what? I’m ready to invest at same price as last run.”
I think you should take it. It’s like an insurance policy. Yes, it might dilute you a bit, but what it might add in term of runway is a big difference. As we just said, a lot of great companies lost 50% market cap in a year. So if you’ve got an offer to get more cash at the same valuation as your last run, you should just take it. You will have to be so amazing business to feel is not the right values these days.
Nuno G. Pedro
I think the final two elements of knowing that you’re relatively safe are around top line and cost, and they’re really around predictability. If you have a relatively predictable top lines because of the length of contracts you have in place, because of the low probability of default of some customers that you have at the table, meaning they’re trustworthy with good or solid businesses, because of how you really see the business evolving on the top line.
Again, very important to make this assessment. They’re trustworthy customers. They’re happy with what they’re getting from you. Their business is also doing okay or doing well. If you have clear top-line predictability, that’s normally a good proxy to being relatively safe because even if you’re unit economics don’t work right this moment, you can maybe tweak some of your costs to make it work. Maybe you don’t actually need that heavy structure on the sales side. Maybe you don’t need that heavy structure on customer success, or maybe you do. There’s things you can probably tweak to make your unit economics work.
The opposite is also true. It might be that actually your top line is a little bit more variable, but you can work a little bit with your cost predictability and that you can have a much better view on cost predictability. One thing that is very clear to me, for example, hardware-led businesses in the last two years have suffered a lot from supply chain shocks, from difficulty in sourcing materials, from increasing costs in logistics.
If you at some point, actually my cost base is super predictable, that’s a huge advantage you have. That might be the difference, again, between the companies in trouble or who are sort of relatively safe because I have a very clear understanding with all the variables that I have, that I have a very clear understanding on where my costs are. They’re just actually relatively predictable, and so I can just maintain the company based on that.
Yes. On that one, I would say that there are definitely some exceptions. As you say, hardware-based companies these days, it’s very tough to get predictability. But except for some of these industries, I think that the least you could do is to be predictable about your cost. Selling is hard, but making sure you manage cost to your plan; you manage EBIDTA to your plan. Even if the top line doesn’t go as well as expected, I think the expectations of not everyone around the table is at least EBIDTA is doing per target.
I think that one is really critical. There is much less externality usually to manage and control your cost, so you should really be good at that. And if you’re in a space like hardware where you depend on a lot of externalities, it needs to be part of your job to get better at that and to become world-class at predicting costs in your industry because that’s the game. In your world with a lot of inflation of all supplier issues and stuff, that’s really becoming one of the box that you have to fill to become a good hardware company, and people are going to look into that.
Nuno G. Pedro
Not only predictability everyone always says, “Well, the hardware guys have more trouble,” some software companies also have sometimes issues with cost predictability when it comes, for example, to their infrastructure, to their cloud infrastructure. I’ve recently gone through renegotiations in some of the companies that I’m on the board of with very large cloud owners of the world. Some of these negotiations haven’t been going well.
In some cases, it’s led to a point where it’s difficult to really trust that the other party is doing the right thing because they themselves are trying to increase their profits and they’re trying to get better unit economics on their own businesses. Some of them are gigantic companies, but they don’t really care.
Again, cost predictability is sometimes a little bit more complex than one would think. It’s not just I believe a hardware versus software issue. It really depends on what are the big levers of variable costs in your business.
We have reached the end of Episode 35, our first episode on what to do when your company is in trouble. We talk about the market context. We talked about how to know your company is in trouble. We talk about how to define not being too much in trouble, being relatively safe. In next episode, we’ll talk more about what to do if your company is in trouble, and hopefully not, but what happens if all is failing? What are your options? Thank you very much.
Nuno G. Pedro
Thank you, Nuno.