10 Tips to Avoid Layoffs When a Startup is Running Out of Cash

What is the number one reason for startup failure? Running out of cash is one of the main reasons for startups to fail.

There are plenty of indirect and direct reasons for startup failure, such as lack of market demand, ineffective marketing, launching a product too early or too late, wrong business model, issues with the team, unfavorable regulation, inaccurate pricing, issues with the product, competition and many more.

At the end of the day, each of the aforementioned problems drags the startup company into gradually burning all of its cash reserves, drying up credit lines, and leading to the inevitability of shutting down the company.

Who should keep reading this article? The founders whose startup companies have a runway* below 12 months

* What is “runway”? Runway is the number of months a startup can operate before it runs out of money; the formula to calculate a startup runway is the following: take the existing cash balance and divide it by the amount of cash that the company is losing each month. To learn more about this and other VC terms, please follow Leta Capital’s VCpedia.

For those founders who are in their lucky position of having a healthy runway of 12+ months, I recommend reading Firstmark’s Treasury Playbook, as well as a16z’s Cash management guideline.

According to the resources, more than 1 million tech startups are created worldwide each year, with an average failure rate between 60% and 80%. Moreover, the problem of running out of cash for a startup is not new, and there are plenty of resources out there available for founders to help navigate through the low runway situation. Try googling “what to do if your startup is running out of cash” or ask the same question to an all-knowing GhatGPT.

Are layoffs actually inevitable?

The most popular recommendation for founders whose startup companies are running out of cash is cutting costs. For a typical tech startup, the biggest cost is payroll, which means that founders have to let go of employees or sometimes entire departments. Laying off even a single employee is highly stressful for both founders and the team, which eventually might affect the morale of the remaining employees, creating a sense of insecurity, as well as slowing down growth potential.

Moreover, if you are still in a position of having a runway between 3 months and 12 months from now, you may want to explore all possible options for extending the runway without the need to lay off employees while letting go of staff should be a last resort.

1/ 🧳 Revisit your company expense policy

Try cutting non-essential expense categories such as travel expenses, expenses on the training of employees, marketing and entertainment subscriptions (trade journals, magazines, etc), office snacks, company events, etc. Identify and cut all non-essential overspending and overhead costs across all departments. Encourage your team to work from home, reduce travel, and use any other available cost-saving measures.

2/ 💳 Negotiate with vendors and suppliers

Reach out to vendors and suppliers to negotiate better pricing or payment terms to help reduce expenses. Research alternative suppliers, prioritize vendors that provide essential goods or services to the company, and focus negotiations on reducing costs with those vendors first. Offer incentives to vendors such as long-term contracts or the promise of more business in the future to get better pricing. Don’t forget to document all agreements reached with vendors to ensure there is a clear understanding of the terms and conditions.

3/ 💰 Explore alternative financing options

Given the time constraints, based on our own experience, as alternative financing external equity rounds, I would recommend prioritizing the following three options:

1. Venture Debt (venture debt is a form of debt financing designed for startups that have previously raised venture capital funding)
2. Ask existing investors/shareholders to support the company and provide additional financing
3. Revenue-Based Financing, which involves receiving upfront capital in exchange for a percentage of future revenue.

4/ 🤑 Increase revenue-generating efforts

Increase sales and marketing efforts to bring in more revenue.

1. Try revisiting your pricing strategy: I heard multiple times from startup founders about their success stories of rising prices significantly for their products or services that didn’t result in increased customer churn.
2. Be creative with your pricing: for the sake of getting as much in immediate payments or upfront payments as possible, try selling more lifetime deals or packages.
3. Temporarily stop experimenting with new sales channels and partnerships, given the time constraints prioritize only working channels and sales processes that you can manage end-to-end
4. Double down on your BOFU (bottom-of-funnel) marketing activities and make all relevant employees (even outside of sales & marketing departments) get somehow involved in helping close the deals with worm leads.
5. Improve your accounts receivable collection process. On this, check out some handy tips from our portfolio company.

5/ 🧾 Delay payments

Ask your creditors if you can delay payments for a short period of time. Explain your financial situation to the creditors. Ask if they are willing to grant you more time to make payments. Ask if you can extend your payment terms, for example, by paying in installments over a longer period of time. If you cannot pay the full amount owed, offer to make a partial payment to show your commitment to paying off the debt. Also, you can try offering to create a payment plan that shows how you will pay off the debt over a specific period of time.

6/ 🪪 Upsell and cross-sell to existing customers

Existing customers already have a relationship with your company and are more likely to trust you. Try offering additional products or services to your existing customers to increase revenue per customer.

7/ 👉 Ask existing customers to refer you to new customers

Use referral links or an email template that they can use to introduce your offering. Provide existing customers with an incentive, such as a discount or credit.

8/ 🤔 Seek advice

Speak with your board members, investors, shareholders, mentors, industry experts, or other founders who have faced similar challenges. Some of them may have valuable insights or suggestions that could help you avoid layoffs

9/ 🛑 Implement a hiring freeze

Pause hiring for non-essential positions until the company is in a better financial position

10/ 🔻 Reduce salaries temporarily

Consider asking employees to take a temporary pay cut in exchange for job security and future equity. It’s important to establish clear policies and procedures for the temporary salary reduction, incl. the duration of the reduction and how it will be implemented. Also consider offering flexible payment options, such as deferred compensation or equity, to help offset the impact of the salary reduction.

Bonus tip: 🗣️ Communicate with employees

Be transparent with employees about the startup’s financial situation and involve them in the decision-making process as early as possible to find a solution together.

Do you run an innovative tech startup? We are investing in early-stage revenue-generating software startups across the world and would love to hear from you! You can reach us at info@leta.vc or fill in the form here.