Hyper-growth is great, but don’t die while trying
How to avoid bad surprises when you’re planning for fast growth
Companies perform according to plan … until they don’t. That’s a tautology/joke, obviously. What I mean is that it quite frequently happens that companies go from “more or less according to plan” to quite drastically below plan in just a couple of months.
There are a few mathematical and psychological reasons for this phenomenon, and I’ll try to unpack them (and make some suggestions on how to address them) in this post. But before we dig in, you might be wondering whether it actually matters. Perhaps your plan is just your best guess, you’re doing as well as you can, and you’ll update the plan along the way. So why does the “plan-to-actuals” comparison even matter?
There are situations where this objection would be right. For example, when you’re very early and have a low burn and lots of runway. However, many (maybe most) fast-growing startups are not “default alive”, meaning they have to raise a new financing round at some point. This is where things get tricky, especially in the current macro environment where fundraising is most likely going to be much harder than it was a few months ago.
The double-whammy of lower-than-expected growth
Even a seemingly minor underperformance of your top line can hurt your funding prospects in two ways.
First and most obviously, a lower growth rate makes it harder to get new investors excited. Of all the factors that make a startup more or less exciting for investors, growth is the clear #1. If you look at the results from our annual SaaS napkin surveys, you can see that the bar is pretty high: if you’re at around $10–15 million ARR, you generally have to grow 2x year-over-year to get investors excited. If you’re below $10 million ARR, you have to grow even faster to get investors to jump out of their seats. That doesn’t mean that you can’t raise at all if you’re growing slower, but it will be more difficult.
Second, unless you manage to adjust your costs very quickly, lower revenue growth leads to a disproportionately higher burn rate and shorter runway. To get a better sense of this effect, let’s look at the plan of an imaginary SaaS startup that we’ll call Acme, Inc.:
Acme is at $4 million ARR and has just raised $12 million. The company plans to triple its ARR to $12 million within the next 12 months and plans to reach $19 million after 18 months. To achieve its ambitious growth targets, Acme is going to spend aggressively on sales and marketing while continuing to invest in R&D. Based on the company’s costs ramp-up and the projected revenues (which, to keep things simple in this model, are all assumed to be billed monthly), the company has almost one and a half years of runway.
Now let’s fast-forward six months and see how Acme has been doing:
In the last six months, Acme has grown from $4 million to $6.2 million in ARR. Not quite as fast as projected, but not bad. The company’s cost base has increased according to plan. (It is, of course, unrealistic that costs have developed precisely as planned, but hey, this is a simple modeling exercise.)
Based on this development, Acme decides to revise its forecast. In the last six months, Acme’s monthly ARR growth has been about 7% on average, so the company decides to use that growth rate for its projections. Note that while 7% is lower than the 9.6% from the original plan, it still requires the company to consistently add more net new ARR each month, something it has not managed to do in the past.
What you can see in the table above is that if Acme keeps spending according to the original budget, it will run out of money in month 14. Since we’re at month six already, the company has only seven months of runway left!
If Acme wants to address the problem by slashing costs, it must act very quickly. Otherwise, it’s too late. That’s why it’s so important to be on top of your numbers.
Reducing costs is not the only way to address the scenario I’ve described. If you’re highly confident that you can increase your growth rate again quickly, and if you have enough runway or investors who give you a bridge, you may decide to push through. You might be able to save your way or spend your way out of this mess. Your best bet depends on various factors, primarily your level of confidence that you’ll be able to rekindle growth quickly.
From sunshine and lollipops to doom and gloom in just a few months?
Acme started out growing 3x year-over-year and having 18 months of runway. Only six months later, the company is looking at a runway of only seven months and finds itself in a situation where it has to lay off people, find a way to grow much faster very quickly, or raise a bridge round. How is that possible?
The simple answer is that Acme’s burn rate was too high from the get-go and that it should have had a larger buffer and longer runway. But let’s dig in a bit deeper.
1) Until they have experienced sales, marketing, and finance leaders, most companies project to grow exponentially. What I mean by this is that a company that aims to grow 3x year-over-year will typically assume that it will grow ca. 9.6% month-over-month. As a result, a large portion of the growth in terms of absolute dollars is expected to come in the second half. If you plan to grow from $1M to $3M ARR in 12 months, at a constant monthly growth rate, your goal for the six-month mark is $1.73M ARR. So only $0.73M of net new ARR is needed to hit your plan in the first half vs. $1.27M in the second half.
A consequence of this is that you may be almost on track for some months, but unless you actually grow exponentially, the actuals-to-plan gap will widen every single month. Continue like this for just a few months, and you can end up in Acme’s situation.
2) The “almost on track” issue is even more pronounced if you look at plan vs. actuals of your Total ARR. A significant underperformance in net new ARR can appear much less dramatic if you look at total ARR.
Here are Acme’s actuals vs. plan numbers for total ARR and net new ARR:
Looking at total ARR, you might conclude that everything is fine because you’ve achieved 90% of your objectives. Looking at net new ARR reveals that things aren’t working as planned.
3) A lot of the costs of a startup are heavily front-loaded: Recruiting and training salespeople, product development, content marketing, brand building, you name it. If things go well, these expenses are investments that will yield a great return and will lead to a defensible business in the long run. As long as you keep growing as planned, it’s all fine. However, if you grow slower but keep spending as if you were growing 3x year-over-year, your burn rate will skyrocket.
4) I promised you a psychological factor, so here it goes. All entrepreneurs I know are optimists. If you’re not an optimist, by definition you almost certainly won’t start a company. As we said in this video, when you start a new company, the odds are stacked against you. It takes a certain type of person to believe that you can beat the odds.
Entrepreneurs won’t panic if things don’t go according to plan, and neither should they (or their investors). But if a founder’s personality is very far on the optimistic side of the pessimistic-realistic-optimistic scale, it may lead them to react too late in the scenario I described above.
Here are a few tips and tricks that might help you avoid bad surprises:
- Always keep a close eye on net new ARR.
- Keep in mind that at a low scale, seemingly minor underperformance may signal something more serious, especially if it gets bigger every month for a few months in a row. If the gap between planned and actual net new ARR keeps widening for a few months, it’s time to look at your budget and forecast.
- Consider flattening out your growth projections in terms of net new ARR, i.e. consider projecting a declining % growth rate over time. (This may or may not work for you, it’s just something to think about.)
- If you do plan to grow at a constant % growth rate m/m, be super aware that you have to add more net new ARR every single month. Otherwise, your % growth rate will deteriorate quickly.
- Estimate your runway based on more conservative revenue growth. If you plan to grow ARR by, say, 3x y/y, have a backup plan showing how much runway you have at a significantly lower growth rate. The trade-off here is that if you plan for too much runway, you may hinder your growth because you won’t spend enough on sales and marketing. The right balance depends on how confident you are in your ability to scale-up customer acquisition, as well as your ability to scale back costs quickly if needed.
- Lastly, some evergreen advice that I’ve given many times before. Be aware that until very, very late in a startup’s life, you don’t really know how your CACs will develop as you scale until you try it. You may have data points indicating the scalability of your customer acquisition channels, but there’s always uncertainty.