“Have you thought about what will happen if the market changes?”
“Well, we thought about finishing fundraising as fast as possible.”
“I’m not talking only about getting money, but actually surviving. In terms of costs and sales.”
There is something we don’t grasp yet, and it’s that when markets turn around, you think they will come slowly but they also do suddenly. It is not our fault, we have never been on a down cycle*. If you have and you are still working on the same startup, then you are already 6 years in and the questions should be different (“are you still growing?”)
When I think about what could happen I always come with two variables: when and what. When will the market change and what have I done to cover my ass in that situation. The first variable is totally uncertain. No one can time the market. No one. You can see trends and estimate but as journalists claiming for a “bubble” they have no idea when it will come( have been talking about it for the last 10 years). Due to the fact that you can’t by any means affect when will it happen, what can you do about it?
Well, I call it Contingency Plan. It goes to answer the second question. The What should I do in case the bubble burst or the down cycle comes? (to be clear, they are not the same). Some people say: “You shouldn’t have a Plan B!” To be totally clear, this is NOT a Plan B. This is a Contingency Plan for when the shit hits the fan faster that you can even think about it.
If you are one of the lucky companies that went through YC and you find yourself “default dead” then you should probably schedule office hours with Paul Graham as soon as possible. Usually, what you can do at this moment depends on each company and their particular situation. That said, I would like to mention some things that I believe a Contingency Plan should have:
One or the main reason you are probably needing a Contingency Plan is because you are burning money too fast. As Paul Graham mentioned in this post it usually means that you hire too fast or you hire thinking that will solve your problem. The counterintuitive thing about it is that you think hiring can save you but it only diggs you deeper into the hole (kind of what happens on the movies when you are in quicksand).
The question you need to ask yourself and answer in your contingency plan is: How many people do I really need to run this company? The trick here is to be absolutely rational, and just write down the positions and tasks each one needs to do. You can’t add names to them. If you do, then the human part of your will come in and make you doubt about firing anyone. Once you write it down, then you compare with what you have today. I would say that 20% of the team is not necessary when you cross the 5 people. It means that 1 every 5 persons can be fired and their tasks can be done by others.*
The good thing about writing it down in advance (for the different stages of the company ~6 to 12 months) is that you are trying to be rational and scientific on the decisions. Be honest with yourself and with those that you bring on board.
Now, there is a tentation of a founder of using the measures all the time to keep the team slim and the burn rate low. Even if it seems as a good idea, it shouldn’t be used all the time. Markets don’t change at the same speed as people learn and developed. A good bet on an employee today can take some time to return.
This is kind of the other side of the history. When things go bad usually sales drop fast and people tend to focus on them instead of the product. I recommend have a simple stress test on the sales with 3 scenarios. What happens when sales drop 20%, 40% and 60% in numerical value and in quantity of clients. Thanks to our friend Pareto we have the 20/80 rule that in long terms seems to apply. That is why you should not only focus on $$ but also on quantity of the clients and who they are. It should also be written down how many clients (and $$) you need to keep the team running. Not the team today but the team we restructure in the previous point (after you fire). This relation between cost/sales helps you determine where do you need to focus and on who.
What to do? Well, this is very specific to each company. My little experience says to focus on loyal clients that will stay alive.* Before I would have said “big clients that bring most of the money” but it is not directly correlated to their loyalty to you or how good their business is. This is more of a defensive play and the most common used. We could also be aggressive and tried to get those clients from our competitors that can bring that extra cash you need. Would not recommend it on a down cycle, but it could work.
You thought that a Contingency Plan is a very complicated and long thing to do? It’s not. You need to know which positions you need to keep running the company and those you don’t. Also write down who are your clients and how much do they bring (as also what is their situation). Keep this clients close to you and in constant communication. They are your life.
- This numbers come from a analysis we did for a specific company. The interesting part is that we did the analysis on different stages of the company along 5 years and they will always come to the same conclusion.
- To be clear here. I have been in down cycles but not running a startup, but working close to them doing consulting, sitting on the board and seeing it happen. I still have to try this theory myself.
- I come from a third world (small) country. Market shifts there are fairly different than in the U.S. Now, the basics and principles applies wherever you are.