4 Startup Tenets that Won’t Survive a Downturn

I spent the go-go days of the late 90’s in a rare Internet startup for the era. Due to groundwork laid before I arrived, we were profitable. We declined most of the VC we were offered, watched our overhead, and grew methodically. We were misfits of the so-called “new economy,” and we sold for 30x capital invested right as the bottom fell out of the Internet industry.

What I learned from this experience is that industry dogma emerges when startups are hot. And that same dogma is discarded just as quickly when things collapse.

During the recent startup boom, we’ve seen a new dogma emerge. When the cycle ends, I’m expecting the following 4 tenets to disappear along with the good times:

1. A million dollars isn’t cool, a billion dollars is cool

Call me old fashioned, but I think a million dollars is cool, especially if you invested far less than a million dollars to earn it. Somehow, we’ve arrived at a point where “real” entrepreneurship is about pursuing long odds of massive outcomes, and anything short of that is dismissed.

Long odds work fine across a VC portfolio, which is probably why they have become the standard. But just because the formula works well across a VC’s portfolio, doesn’t mean it works on an entrepreneur’s single asset.

I mostly cringe at this tenet because I think it does an enormous disservice to first-time entrepreneurs. Launching a longshot, burning through someone else’s capital, then shutting down is a terrible way to cut your entrepreneurial teeth. Successes are just as important to learning as failures. If you get scorched so bad on the first one that you never try again, how is that “real” entrepreneurship?

2. Never give up

Giving up has its place. I have experienced that startup phenomenon where one day the future looks bleak, then the next day it doesn’t. But I have only experienced it when I knew that fundamentally, we had something of value. I have also experienced being in a hole with no way out, where the best move was to look for a soft landing.

As a steward of other people’s capital and time, there is nothing heroic or romantic about squandering either on a lost cause. Sometimes, the right thing to do is to redeploy what’s left into something more productive.

3. Hustle & grind, always

Speed is critical to startups. Given the fact that big incumbents have all the people, money and customers they need to squash new entrants, you could even say that speed is the only advantage at startups. I love the hustle & grind.

At the same time, two of my most positively pivotal moments came when business got so bad that I stopped hustling entirely. I stepped back, stopped selling, thought hard about the business, and made fundamental changes. Had I just kept grinding, I would have undoubtedly ground the business into dust.

You can’t hustle your way out of a bad business model. Sometimes, you have to pull back resources, stop, and think hard before you make your next move.

4. Profitability is idiotic

I recently watched a prominent VC tell an audience, “founders who think about profitability are idiots.” Verbatim. His logic — SaaS companies sell on a multiple of revenue, so you should plow all your available resources, including profit, VC and debt, into that metric.

I understand the math, and it works as long things are going well and continue to go well. But you can’t gracefully step off of that treadmill if you stumble. Most startups (and markets) stumble, so again, this tenet is designed for the exception not the rule. A plan for profitability is far from idiotic; it can be the difference between success and failure.

Wouldn’t it be great if we could boil startup success down to a handful of universal truths? But startups are working with too many variables to abide by dogma. The dogma only emerges when startups are so hot that hype drowns out complexity, which never lasts for long.

6 Metrics that are More Important to Your Startup than Revenue

When asked about “traction,” entrepreneurs assume it’s in reference to revenue. Revenue seems to have eclipsed other metrics as an overall indicator of how well the business is doing.

I think the rise of revenue has something to do with blowback from the late 90s, when we suspended traditional financial indicators for our so-called new paradigm. It did not end well. We learned the hard way that financial indicators are important, so we returned to them with a vengeance. “Engagement, whatever…how much money are you making?”

In our back-to-basics approach, we’ve buried some metrics that are more important than revenue because of what happens to most startups; they either die, or are acquired by a bigger company. Revenue itself isn’t the main driver of those outcomes. Acquisitions are more likely to come from how your product can be applied to a much larger installed base of customers, or how your tech or market presence can accelerate an acquirer’s roadmap.

Your revenue might give an acquirer a sense of your viability as a standalone business, thus setting a lower bound on what they will offer. But it will not set their value on your company.

Here are 6 metrics that matter more than revenue:

#6 Gross margin

Gross margin doesn’t tell a story by itself. There are plenty of great low-margin, high-volume businesses. Gross margin is good for gauging how many options you have at your disposal. A high gross margin usually means you can adjust if things don’t go as planned. For example, you have room to drop price if competition stiffens, or you can make a move to profitability if financing gets tight.

#5 Liquidation preference

Liquidation preference is simply the “first dibs” preferred shareholders have on your proceeds from a sale. It’s the bar you have to get over before you can divvy proceeds to other shareholders like founders, employees, etc. It’s not debt, but it can sure feel like it when you are trying to make all classes of shareholders happy. Liquidation preference puts boundaries on your available strategic options. If liquidation preference is high, you can forget about being satisfied with dominating a small niche, or taking a modest acquisition offer (unless it’s that or fold-up entirely).

#4 Revenue concentration

There are various ways to measure revenue concentration; all of them gauge how much of your revenue is at risk from losing your top customers. High revenue concentration puts a serious pinch on valuation because a single instance of churn can send the company into disarray. A typical treacherous startup path: chase big customers to drive revenue growth, add overhead to cover problems with an immature product and keep those customers, end up in a more precarious spot than had you foregone the revenue altogether.

#3 Months to cash zero

Running out of cash is obviously very, very bad. Not much else to say except, if you are driving revenue at the expense of your cash runway, you should have a good plan for how that turns around.

#2 Churn

Assessing whether your customer churn is high or low can be complex. There are markets with endemic churn, like weddings, infant care, Realtors, SMBs, as well as business models with endemic churn. It’s important to have your own internal benchmark. Like an EKG monitor flat-lining, when churn is high, you stop what you’re doing and address the root issue. The root issue can be hard to uncover. It can be pricing, support, missing features, bad tech, renewal timing, or competition. Whatever the case, as long as the problem goes unaddressed, all the resources you are spending on sales and product are potentially for naught.

#1 Cost of the problem you are solving for would-be acquirers

Ultimately, the value of your company will be measured by the problem you solve for an acquirer. That problem is either (a) product (capabilities, features, something new to sell to their customers), or (b) market (an entry point into a certain type of customer). Value is not simply a matter of what it costs BigCo to build your product, although that is part of the equation. It’s mostly a matter of how long it would take them to build it, and the opportunity they are passing up in the process. Projects can move slowly in a big company, and the ability to unlock value now can justify a high price.

Focusing on revenue for an outcome that won’t have much to do with revenue is like training for Sport A, then playing Sport B. A lot of the skills you learned will transfer, but you would have been better off practicing directly relevant skills all along

Before You Adopt the VC Playbook, Make Sure You’re Playing the Same Game

Venture capital can create opportunities that would be nearly impossible without it. But it also takes options off the table. It is important to consider whether objectives are aligned before assuming you need or want VC.

There is a very important difference between VCs and entrepreneurs that is the root of potential misalignment. VCs are optimizing the return on a portfolio of many, whereas entrepreneurs are optimizing the return on a portfolio of one.

VCs have converged around a model where a few companies with outsized returns cover the return of the fund as a whole. The implication is that most VCs are looking for investments with the potential for huge wins, even if the wins face long odds. They are concerned with odds across their portfolio, not a single investment.

As an entrepreneur, however, the odds facing your company are the only odds that matter.

Would you rather face (a) 50% odds of selling your company for $5M, or (b) 5% odds of selling your company for $100M?

The latter, right? But what if in the latter, your ownership dilutes in half, and the outcome takes 5 years longer to achieve? Now the former is more attractive. It is important to consider these dynamics before committing to the pursuit of a big outcome, because if the commitment involves investors, it might be impossible to unwind.

VC not only affects your definition of a good outcome, it also affects your operational strategy. The VC playbook is go big or go bust; get the unit economics right, then pour gas on sales and marketing to get your winners to scale as fast as possible. The problem with this approach is that oftentimes early signals are skewed. Unit economics can look promising as you sell to early adopters, then fall apart as you move into the broader market. If you run up a big tab to find this out, it can be very hard to recover.

On the other hand, if you grow your business in smaller incremental steps as you turn unknowns into knowns, it’s much easier to recover from missteps. You keep the option of something in-between go big and go bust.

It is understandable why the default approach is to pursue VC. Accelerator programs will coach you on your investor pitch, and advise you to create a narrative around massive potential. The press lavishes praise on companies when they raise big rounds of VC. Social proof points to VC as a necessary stop on your way to success.

But the VC playbook has a trade-off in that it eliminates the successful middle ground. Just make sure you’re comfortable with the trade-off before you adopt the playbook.