The First Question I Ask Startups
When I talk to a startup that’s been operating for more than 8 or 9 months, the first thing I want to know is almost always the same. Assuming their expenses remain constant and their revenue growth is what it has been over the last several months, do they make it to profitability on the money they have left?
Or to put it more dramatically, by default do they live or die?
The startling thing is how often the founders themselves don’t know. Half the founders I talk to don’t know whether they’re default alive or default dead.
If you’re among that number, Trevor Blackwell has made a handy calculator you can use to find out.
Why It Matters
The reason I want to know first whether a startup is default alive or default dead is that the rest of the conversation depends on the answer.
If the company is default alive, we can talk about ambitious new things they could do.
If it’s default dead, we probably need to talk about how to save it.
We know the current trajectory ends badly. The question becomes: How can they get off that trajectory?
Why Founders Often Don’t Know
Why do so few founders know whether they’re default alive or default dead?
Mainly, I think, because they’re not used to asking that. It’s not a question that makes sense to ask early on — any more than it makes sense to ask a 3-year-old how he plans to support himself.
But as the company grows older, the question switches from meaningless to critical. That kind of switch often takes people by surprise.
Start Asking Early
I propose the following solution: instead of starting to ask too late whether you’re default alive or default dead, start asking too early.
It’s hard to say precisely when the question switches polarity. But it’s probably not that dangerous to start worrying too early that you’re default dead, whereas it’s very dangerous to start worrying too late.
The Fatal Pinch
The reason is a phenomenon I wrote about earlier: the fatal pinch.
The fatal pinch = default dead + slow growth + not enough time to fix it.
And the way founders end up in it is by not realizing that’s where they’re headed.
The False Comfort of Easy Fundraising
There is another reason founders don’t ask themselves whether they’re default alive or default dead: they assume it will be easy to raise more money.
But that assumption is often false — and worse still, the more you depend on it, the falser it becomes.
Maybe it will help to separate facts from hopes. Instead of thinking of the future with vague optimism, explicitly separate the components:
“We’re default dead, but we’re counting on investors to save us.”
Maybe as you say that, it will set off the same alarms in your head that it does in mine. And if you set off the alarms sufficiently early, you may be able to avoid the fatal pinch.
Can You Safely Be Default Dead?
It would be safe to be default dead if you could count on investors saving you. As a rule, their interest is a function of growth.
If you have steep revenue growth — say over 5x a year — you can start to count on investors being interested even if you’re not profitable.
But investors are fickle. Sometimes something about your business will spook them even if your growth is great.
So no matter how good your growth is, you can never safely treat fundraising as more than a Plan A.
You should always have a Plan B as well:
Know (as in, write down) precisely what you’ll need to do to survive if you can’t raise more money.
Know precisely when you’ll have to switch to Plan B if Plan A isn’t working.
Growth vs Spending
In any case, growing fast versus operating cheaply is far from the sharp dichotomy many founders assume it to be.
In practice, there is surprisingly little connection between how much a startup spends and how fast it grows.
When a startup grows fast, it’s usually because the product hits a nerve, meeting some big need straight on.
When a startup spends a lot, it’s usually because the product is expensive to develop or sell — or simply because they’re wasteful.
How to Avoid Being Default Dead
If you’re paying attention, you’ll be asking at this point not just how to avoid the fatal pinch, but how to avoid being default dead.
That one is easy: don’t hire too fast.
Hiring too fast is by far the biggest killer of startups that raise money. [2]
Why Founders Overhire
Founders tell themselves they need to hire in order to grow. But most err on the side of overestimating this need rather than underestimating it.
Reasons founders overhire:
There’s so much work to do — and naive founders think that if they can just hire enough people, it will all get done.
Successful startups have lots of employees, so it seems like that’s what one does to be successful.
But in fact, large staffs are more the effect of growth than the cause.
When growth is slow, founders don’t want to face the real reason — the product is not appealing enough.
Plus, founders who’ve just raised money are often encouraged to overhire by the VCs who funded them.
Kill-or-cure strategies are optimal for VCs because they’re protected by the portfolio effect.
VCs want to blow you up, in one sense of the phrase or the other.
But as a founder, your incentives are different. You want above all to survive. [3]
A Common Way Startups Die
Here’s a common way startups die:
They make something moderately appealing and have decent initial growth.
They raise their first round fairly easily because the founders seem smart and the idea sounds plausible.
Growth is ok but not great.
The founders convince themselves that hiring a bunch of people will boost growth.
Their investors agree.
But growth never comes.
Now they’re rapidly running out of runway.
They hope further investment will save them — but because they have high expenses and slow growth, they’re now unappealing to investors.
They can’t raise more, and the company dies.
What They Should Have Done
What the company should have done is address the fundamental problem: the product is only moderately appealing.
Hiring people is rarely the way to fix that — and more often than not, it makes it harder.
At this early stage, the product needs to evolve more than to be “built out,” and that’s usually easier with fewer people. [4]
Why Asking Early Helps
Asking whether you’re default alive or default dead may save you from this.
Maybe the alarm bells it sets off will counteract the forces that push you to overhire.
Instead, you’ll be compelled to seek growth in other ways:
Doing things that don’t scale
Redesigning the product in the way only founders can
For many (if not most) startups, these paths to growth are the ones that actually work.
The Airbnb Example
Airbnb waited 4 months after raising money at the end of Y Combinator before they hired their first employee.
In the meantime, the founders were terribly overworked — but they were overworked evolving Airbnb into the astonishingly successful organism it is now.