How to manage running out of cash / doing a down round
One of the most brutal things you’re going to have to do at some point in your career as a founder is deal with running out of money.
It happens to everyone if they’re in the game long enough — and boy does it suck. I saw the world’s greatest living entrepreneur run out of money, in fact. It happens, it sucks.
Goal: In this piece I’m going to explain to you how to save your business if you run out of money.
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Now, the worst part about running out of money is that you lose all leverage with your current and future investors. Paradoxically, when you have a ton of money in the bank, and your business is doing reasonably well, investors will chase you down the street and try and throw bags of money into the back seat of your convertible!
The reason folks hate investing in a startup with no money in the bank is because they fear they will be “bad money after good.” Translation: they will feel that if they give $500,000 to a business that has just burned $2m — and that currently burns $100k per month — all they are doing is pushing the inevitable flame-out five months down the road.
And guess what, they’re probably right!
Our jobs as founders is to “reboot” the opportunity by re-establishing credibility and re-telling the story.
You have been heads down and thinking you have six months to raise money because you have $600k in the bank and are burning $100k per month. Suddenly you realize that you spent $100,000 more than you thought you did last month because of a trademark lawsuit and a settlement with your former CTO, who you fired with three months of salary.
Oh yeah, you missed your sales target by $75,000 per month for the 4th quarter, so you were down another $225k for a total of $325k in unexpected loss.
You then spent two months trying to clean this up enough to present to your investors — and now you have three weeks of cash left.
This happens all the time … in fact it’s happened to a couple of startups I’ve invested in.
Here is a toolkit of all the things you can — and probably will — have to do.
STEP ONE: ASK EXISTING INVESTORS FOR A BRIDGE
Go to your investors and explain in detail how you messed up and ask for a six-month bridge at the last valuation. If this works, well, you have awesome investors who believe in you and the business. Congrats, you’re done!
STEP TWO: NO BRIDGE FOR YOU!
Your existing investors will be evaluating their options with your startup every time you ask them for money — that is their job, after all.
If you’ve been keeping them up to date on your progress with monthly updates, they will know how you’re doing already so this discussion should go quickly and painlessly (that’s why investor updates are important)!
If you haven’t been in communication with your investors, you will spend the first half of these discussions already behind the eight ball: “So, we haven’t heard from you in months … and now you’re calling because you’re out of money — really?!”
Here is a list of concessions I’ve seen folks do to drum up interest in their cash-strapped startups.
[ Note: I’m not advocating for any of these, which I realize some folks might read into (i.e., “Jason wants a startup to do this … he’s an investor!”). The truth is, I’m an early stage investor and these things usually happen at later stages when it’s in the hands of the VCs. ]
What follows is a list of things I’ve seen friends do in tough situations to get cash:
- Easy: Present a plan to cut your startup’s burn by 25%.
- Hard: Present a second plan that cuts your burn WAY down — 50%+. (Note: investors will usually want you to “cut fat, but not bone” — there is a lot of give and take here.)
- Easy: Offer to have the management team take a pay cut until you hit X milestone.
- Hard: Offer to have the management team take deferred salaries until you hit X milestone (funding, breakeven, etc.).
- Easy: Do a convertible note at the same valuation/cap as the last round — basically saying that there was no gain in enterprise value due to the cash shortfall (even if there was).
- Hard: Do a convertible note at a lower valuation/cap than the last round. This basically says the business is not as valuable as it was, or that you are in such dire straights that you need to sweeten the pot so that folks will invest.
- Easy: The management team has agreed, in aggregate, to do 5% of this round.
- Hard: The management team has agreed, in aggregate, to do 10% of this round.
Here is what that email might look like:
Dear Acme Investors,
As you know, we have three weeks of capital in the bank left and we need to close a bridge round this week. Our shortcoming has required dramatic action on the part of our management team, which is taking the brunt of this hit: 25–50% pay cuts at a minimum, and deferred salary for myself.
While these cuts have been brutally hard, our team is driven to make this business succeed, and for you, our loyal investors, to get a return on your capital. Our new plan and pitch deck are attached, as well as a convertible note that will allow us to raise $600k at a $3m cap — half the value of the round many of you invested in nine months ago. While no one likes to see a down round like this, the upside is you all can participate in it and help the company fight its way to profitability.
If you have any questions I’m available any time, but we would like to know at what level — if any — you will be participating in this emergency bridge round.
All the best, Jane Doe & John Doe, co-founders of Acme Inc.
NUCLEAR OPTION: PUT YOUR PALM OVER THE BUTTON
When you’re out of money and investors pass on giving you a bridge—even one that is at a juicy valuation — you can assume that they have written their investment to zero.
At this point you are now, ironically, back in control because everyone has given up on you. Life’s crazy, huh?
So, in this case you send the following email:
Dear Acme Investors,
We gave it our all, but it wasn’t enough to make Acme work. I’m certain none of us wanted it to end this way, but starting a week from today we will be winding down the business. We hope to return .05 on the dollar to investors in liquidation, but even that is questionable.
We have a created a list of assets and employee resumes, which are attached. If you know of anyone who you think would want to acquire our assets or hire our team let us know.
Finally, I am willing to recapitalize or buy the business from investors if the board can come to a reasonable proposal.
Best regards, Jane Doe & John Doe, co-founders of Acme Inc.
In conclusion: This can be messy business, but most startups fail so the expectation is that things will — well — fail! Take it seriously, but remember everyone involved in this game knows the possible outcomes going in.
Keep it classy, be honest at all times, and ask for help.
all the best, @jason