Flogging A Dead Horse: How To Tell When To Give Up On Your Startup

Tim Jackson
Oct 11, 2019 · 12 min read
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Is your trusty steed default dead or default alive?

Five questions to help decide whether a slow-growing startup should raise more money or give up

Twelve years ago, I went to fundraise for a new startup from a guy who’s a successful and effective operator in the European technology business. The meeting was a perfect illustration of the saying that ‘if you want advice, ask for money; if you want money, ask for advice’. I asked him to invest, and he explained in brutal detail why he wouldn’t invest and didn’t think the business would succeed.

That was the advice; I didn’t take it. His reaction was based on half an hour’s thought. I’d done probably one hundred hours of research on the issues we were discussing, and I thought I knew better than he did. So I went ahead and raised a bit over a million, and started the business. And every time I met him over the next 18 months, he’d ask me the same question: “Are you still flogging that dead horse?

He proved right. But I didn’t admit that the horse was dead until eighteen months later, when I finally gave up and sent out the email to my investors apologising for having failed, explaining what I thought had gone wrong, and letting them know that I’d be returning the chunk of their money that was left.

I didn’t admit the horse was dead for eighteen months

Animal-rights activists wouldn’t like that dead-horse metaphor. The implication behind it is that it’s OK to beat an animal if you want it to work harder, because the fear of pain will make it put in more effort. The mistake is flogging a horse that can’t feel any pain, because it won’t be influenced no matter how viciously you hit it. I’d normally hesitate to revive the metaphor, except that in the startup space these days it’s common to talk about ‘crushing it’ and ‘killing it’ as if companies (customers, or markets) were small animals, and torturing them to death is morally just fine.

But the metaphor of flogging a dead horse is a valuable one, because running startups is really hard. Founders put themselves through enormous effort and stress in an attempt to make their companies succeed, even though they can often make twice the money for half the effort by taking a job in an established business. So it’s a hugely valuable thing to know whether all the effort is being wasted because the company is dead anyway, or whether it’s worth continuing to crack the whip in the hope that just a little more effort might get you past the finishing line.

So how do you tell? How do you know whether the horse you’re flogging is dead or alive?

The standard way of looking at this is quantitative, and the absolutely simplest approach is to consider the question of when you’re likely to run out of money. Paul Graham, founder of YCombinator, wrote an insightful blog post in 2015 pointing out that you should compare the cash you have in the bank against your burn rate and growth rate, and work out what will happen if your expenses stay constant and your revenue continues to grow at the rate it’s been growing over the past few months. You’re ‘default alive’ if the growth rate is high enough that your revenues will exceed your expenses before you run out of cash. If not, you’re ‘default dead’.

It’s possible to be default dead and yet still to have a good business. That’s because companies often take a while to figure out who to sell their product to and how to reach potential customers cost-effectively, and move them through the sales cycle efficiently to the point where they start paying money. A quantitative way to capture this is the Bessemer CAC ratio, named from the venture firm that first came up with this analysis.

There’s lots of complexity and subtlety to applying it in practice, but the one-liner is to look closely at the ratio between the lifetime value from a customer (LTV comes from multiplying the number of months a client will stay with you by the monthly gross margin or contribution margin, not the top-line revenue) and what the customer acquisition cost is. (CAC has to include all the marginal costs of bringing in that new customer: not just your ads, for instance, but also the person who manages them; not just the sales team but also the onboarding team.) If these unit economics are attractive, that’s a signal to start spending a lot on sales and marketing, which results in high growth — at which point the company’s attractive prospects become visible to all, and it’s easy to raise funding.

But if you’ve made recent changes to your product, then your future client churn may be lower than it was in the past, which will increase your LTV. And if you’ve made recent changes to your sales and marketing, then the most recent customers you’ve acquired may have cost a lot less than the early ones where you were experimenting and trying to figure out the best way to bring them in. So a straightforward CAC-ratio calculation may give you a more pessimistic answer than you think is fair: on a historic view, the business isn’t good, but if you take only the last quarter or the last month, it may be fine. (You also need to consider the future, but aim off for your own optimism: most founders believe their future customers will stay loyal for longer than today’s customers, and that their marketing will be more effective in future than in the past, but sadly most founders are wrong. Only detailed analysis and discussion can help you figure out whether your assumptions are well-grounded.)

Most founders expect future economics to be better — but most founders, sadly, turn out to be wrong

You might think these are problems only for very early-stage companies, and I certainly see them often in the seed-stage investments we make at Walking Ventures. But I also see these questions at later on, where my relationship with the company is only as the CEO’s coach. In many Series A companies, and a few Series B companies, sales aren’t growing on plan, and customers are still scarily expensive to acquire.

Yet even if there are concerns, venture capitalists find it hard to take the initiative and raise the alarm for their existing investments. Inbound deal flow comes from referrals, and telling a founder that their business is no good is like telling them their baby is ugly: it doesn’t win you friends. Seasoned VCs understand option value: a 20% stake in a business with a 10% chance of being worth $100m is worth more than shutting down a company early and salvaging $1m in cash from the wreckage. And there’s also a shadier consideration: newer firms that are trying to raise a new fund will often prefer unsuccessful companies to stagger along discreetly in zombie status than to become an unequivocal fail that has to be reported to potential new investors in the VC’s next fund.

So right up to Series B, there’s a need to capture not just raw numbers but also some of the qualitative data on how things are going in order to figure out whether the business is likely to succeed, and whether it justifies more funding. I’d suggest the best way to do this is by considering five statements and deciding how strongly you agree with them.

You might think that’s a long-winded way of saying ‘we’ve launched an MVP’, but here’s the difference. A minimum viable product can be something that you don’t actually expect clients to pay for. One reason might be that you need network effects and the product can’t be valuable to its first few users. But there can be other reasons too. The key question is whether you believe your product ought to be bringing in revenue right now. For your very first round of investment, you won’t need to agree with the statement. But the more money you’ve raised and the longer you’ve been running, the more firmly you should agree.

It’s one thing to have built a good product; it’s another thing to start marketing and selling it. To agree strongly with statement #2, you have to have both built a sales and marketing process and run it for long enough to get enough customers in at the top of the funnel. How many customers should you have approached? Obviously that depends on your target clients; if you’re targeting whales who will pay $1m a year once the product is right, you’ll need a hell of a lot fewer of them than if you’re targeting $1,000-a-year rabbits, as German VC Christoph Janz calls them. But if you have a $10,000-a-year product that you believe is sellable and you’ve only gone out to ten clients, then you’ve got work to do.

Until you’ve reached out to enough clients, your answer to whether you’ve correctly identified your target customer personas and figured out what problems they have and how to position your product to meet those problems is likely to be ‘don’t know’. But once you’ve got enough numbers in your funnel, you can start to tell from the stage-progression rates — the percentage of clients you emailed who replied, or the percentage of respondents who agreed to set up a demo, or the percentage of demos who started a trial, or whatever — how much your product looks to them like a solution to their problem. This is quite separate from whether the product actually solves their problem. When customers say they ‘don’t have budget’, what they mean is that they don’t have budget for you: that is, they’ve got a pile of money to spend on things, but your product doesn’t look like a high enough priority to earn a place on the list.

Obviously what counts as appropriate depends on your product. Larry Page of Alphabet uses the ‘toothbrush test’ as an investment criterion: do customers use the product once or twice a day, and does it make their life better? On this test, Uber is close-but-no-cigar, and AirBnB is nowhere. So there are plenty of great companies that don’t have a habit-forming frequency of usage — and in defining ‘appropriate’, you have to bear in mind your target customer persona. If your product is online consumer banking, you want to see people making it their primary account; if it’s a tool to manage corporate marketing, people should be checking in daily. If it’s a CRM, probably several times a day; if it’s an at-home massage service, you want them to use it for most of their massages, so that may mean monthly or fortnightly. If customers aren’t hitting your target frequency, that means either you’ve targeted the wrong clients or the product isn’t right. Viral recommendation is also an indicator: if people aren’t telling their friends about the product, that’s a bad sign — unless your product provides a competitive advantage they’ll want to keep it secret, or it’s something they may not want to shout to the world about, like a sex toy.

When you first launch a business, there are lots of unknowns. And it’s often easier to raise the first money from investors before you’ve launched, because their response will be more about what they think about the product and the team than about the hard evidence of what customers think about the product and whether those customers buy it. But it’s still valuable to look back at your past plans, and ask tough questions about how you delivered on those plans. Most startups are too optimistic. Don’t blame yourself for that: since the probability-adjusted value of starting a new business is usually less than staying in your day job, VCs would have very little to invest in if most startup founders and CEOs were truly rational. But your optimism has to be rationally bounded. If you’ve raised money two or three times, and each time given convincing reasons for why the business hadn’t taken off yet but promised it would take off once the new money was in, then you won’t be able to agree with statement #5. And you also need to pay attention to how long you’ve been going: if you’re at a much earlier stage, and only expected to have got one or two pilot customers by now, then even if you’re not agreeing strongly with statements #2 to #4, you may still be on track.

If startup founders took a rational view of their chances of success, VCs would have very little to invest in

I’m planning to build a diagnostic tool that will allow CEOs, founders and investors in startups quickly gather and quantify their responses to these statements; if you’d like to be notified when it’s ready, then please sign up for updates using the form above. Meanwhile, you can hack a paper version:

  • We’ll ask the different stakeholders in the company to look at the five statements and evaluate each one by saying whether they strongly agree with it (score 5), agree (score 4), don’t know or are on the fence (score 3), disagree (score 2), or strongly disagree (score 1).
  • Then we’ll average their results for each question. So for an example company, the average response might be 4.5 across all respondents to the product statement, 2.5 to the marketing statement (say because you’ve neglected it), 4 to the conversion statement because once you reach out to people they do actually buy, 3 to the usage statement and 2 to the progress-versus-plan statement.
  • Finally, we’ll multiply the average scores for each statement together. So the score for the example company above will be =4.5*2.5*4*3*2, which is 270.

Expectations of where you should be differ according to how much money you’ve raised, and how long you’ve been going for — and that’s why the word ‘appropriate’ is so important in the statements. But a good rule of thumb could be as follows. If your combined score is more than 1,500, then your horse isn’t just alive, it’s a thoroughbred. The business has great prospects, and you’re likely to be spoiled for choice when you raise money. If your score is over 750, then the business is very healthy. At a score of 500, you’re in the middle of the startup pack, and so you should expect your chance of survival to be about average for the stage you’re at. Below a score of 250, you need to ask serious questions about the health of your horse. And below 100, things will have to change fast if you’re going to survive.

If you find it hard to decide how much you agree with the statements, that’s understandable; industries differ, and products differ, so there’s no quantitative test that works for all startups. But it’s important to remember this: company founders and CEOs — even those who are serial entrepreneurs who’ve done it a couple of times before — usually have only a small data set to compare with. Investors who have dozens of portfolio companies and see thousands of companies a year are in a much better position to judge your company relative to the rest of the investable startup universe. That’s why it’s valuable to bring them into the discussion. But you need to do it in a way that encourages them not to tell you what they think you want to hear, but to give you honest answers.

‘You’re too early for us’ is French for ‘no’

If your investors aren’t hugely value-adding, or you mistrust their judgment, then you may find it helpful to discuss the statements with an advisor, an investment banker, or a coach with investing and operating experience. But if none of those are possible, then you can always fall back on the most reliable, albeit time-consuming and painful, source of honesty: investors you pitch, in large numbers, for funding. Don’t pay any attention to what they say: the answer that ‘it’s too early, but come and see us again in six months’ is French for ‘no’. Instead, pay attention to what new investors do when you reach out to them. Only the rarest and most confident investors will dare to give you an honest answer as to whether you’re flogging a dead horse.

I’m Tim, and these articles come from my work coaching Series A and B CEOs backed by VC firms in Europe, America and Asia. Since 2013, I’ve run a seed fund out of London that invests in SAAS, platforms, marketplaces and tools. I’ve backed 50 companies, sat on 19 boards, founded some startups. Before that, I worked for The Economist and the Financial Times and wrote business books.

This is one in a series of blog posts covering nine of the most important skills I’ve seen in founders who successfully scale their companies. If you’d like to read more of them for free, please sign up using the inline form above.

Image credit: Danny Galegos

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