It has been widely reported that at there will be least 1,000 orphan startups this year - companies that raised a seed round last year and will fail to raise follow on financing. The popular opinion in the tech press is that most of these 1,000 orphan companies will die due to lack of capital. As a founder, it's hard not to let this influence your thinking - with all the talk of failing fast, acqui-hires, and overnight success stories, it's easy to believe that your only options are to find a soft landing or shut down and try again with something else. And compared to sticking it out, walking away is most certainly the easier path (although it might make you a punk).
But I believe that in those 1,000 orphan startups, there are great companies - companies that can still put a dent in the universe, companies that can break through if the founders stick to it. Ben Horowitz says that all great CEOs have one thing in common: they don't quit, and at Startup School last year, this theme played out over and over again. Almost every founder that spoke went through a trough of sorrow that lasted 18-24 months before things really started to click for their companies.
Maybe it’s coincidental that the trough of sorrow is usually just a bit longer than the runway you have after an average-sized seed round, but I’m beginning to believe that great companies are often the product of these trying circumstances. Unfortunately people don’t like to talk about what’s not going right with their companies, and there’s not much discussion going on around what founders are doing to successfully navigate these waters.
I’m the founder of a startup that recently decided to double down and do our best to beat the series A crunch, and in the interest of focusing on the road instead of the wall, I wanted to share some of the things I’m learning as we find a way forward.
Acknowledging Your Reality
Founders are optimistic people, so it's easy for us to believe that if we just add this one thing to our product, hit that one key metric, or sign that one partnership deal, investors will come banging on our door begging to give us money. However, if you know things aren't going well or you are already having trouble raising your next round, what your startup needs more than anything is a lucid founder that can realistically assess the situation and identify a path forward.
Doing an honest appraisal of the things that were and weren’t working in our business was an important moment for our decision to press forward. Inside the head of a founder, things can seem great one minute and terrible the next, so getting outside perspective can be valuable as a check to your instincts and emotions. Meeting with advisors and existing investors also helped us get some third party perspective about trends in the market and issues we’re facing.
Understanding Why You're Not Fundable
As a startup founder, you're working in a four dimensional problem space: team, product, market, and timing. Hopes and dreams are often enough to raise money at the seed stage, but in my experience, you need more than that for your next round: you need to convince investors that you're the right team building the right product for the right market at the right time.
If you've been fundraising for three months and haven't gotten a check yet, something is probably wrong in one or more of these areas. Understanding what's wrong is critical to figuring out your path forward, and investors that pass can be the best source for understanding what the missing pieces are.
Until recently, I don’t think I quite appreciated the complexity of getting all this right at the same time, especially when you throw in the added complexity of trying to match up with the various investment theses and historical biases of top tier firms. As Ben Horowitz said, “this is not checkers; this is mutherfuckin’ chess.” Getting useful information isn't always easy - most investors seem to be worried about offending founders and prefer high level statements like "not enough traction" over candid feedback about the holes they see in your business.
I want to thank a few folks that were candid and helpful to us in this way - Ashu Garg (Foundation Capital), Thomas Korte (AngelPad) and James Currier were among the the people that gave us really insightful, critical feedback.
The Founding Team Gut Check
With some honest datapoints on the investor perspective of your business, you have the information you and your co-founders need to have a gut check conversation about the state of your business. You'll likely find your product, market, team or timing are in conflict with what investors see as likely to be a homerun, and you need to decide how to respond to that mismatch.
In our case the problem seems to be mainly around market - we're targeting very small businesses, a fragmented market where there is no historical precedent for big winners being built within the timeline that venture investors need for their 10x returns. We're well aware of the historical challenges in serving this market, but we believe that due to a number of new trends, big winners will emerge in this space in the next 3-5 years. Very few investors agree with us.
Our focus on very small business is one of the founding principles of our company, and we believe deeply in the potential that lies in serving this market. Our conviction in serving this market increased when we launched Glyder and started seeing the positive user response to the product. Because of this conviction, we decided that we would rather continue focusing on this market than switch to a different target market, even if that means we're not fundable in the short term.
Having an open and candid conversation with our team about the challenges to our company was a great chance to gauge everyone's commitment to the business. Building our business without more capital will be difficult, but when everyone voiced renewed desire to keep going forward, it helped me as the CEO get excited about figuring out how to do it.
Moving Forward & Changing Tactics
Paul Graham likes to tell founders that "the surest route to success is to be the cockroaches of the corporate world." The analogy works particularly well for orphan startups, because without additional capital, you must be resilient, resourceful and self-sufficient as quickly as possible. Here are some of the changes we’ve made as we continue building our business.
Incentivizing Existing Investors to Stay Involved and Excited
Before we started trying to raise a new round, we gave our existing investors the opportunity to put more money into the company on fairly favorable terms. The cap on this new note was lower than the cap that we had previously raised money on - although our business was much further along, the funding environment had changed as well, and we wanted to make the decision to put additional capital in easy for our existing investors.
We also went back and amended the documents for all investors who had put money in on the higher cap and gave them the lower cap instead. This is unusual, not legally required, and meant that we were giving up additional dilution.
Why would we voluntarily increase dilution? Our investor group includes friends & family, angels, and the great team at 500 Startups. Our relationships with most of them started long before this company, and we hope they will extend far into the future. These relationships motivate us to keep building the business - they trusted us with their hard earned dollars, and although they all know the risks of betting on our startup, we want to show them results. When it comes to a decision like the one we made with the cap change, the cost in dilution was well worth the goodwill it generated among our investors. It also demonstrated our commitment to acting with integrity even when things aren't going according to plan.
Re-evaluating the Product Roadmap
As we heard the skepticism from potential investors while trying to raise more capital, product priorities were the first thing to change for us. We no longer have the luxury to focus on user growth over monetization, so our entire product roadmap shifted to focus on revenue. Our app, once offered for free (to maximize signups) is now a paid download. We don't have the luxury of supporting users that aren't willing to pay for what we make.
Lowering Burn Rate
In addition to shifting product priorities to revenue, we also made dramatic reductions in burn rate so we could reach profitability faster. This meant letting several team members go - by far the hardest decision in this entire process - and asking remaining team members to take a pay cut (we softened the blow with this by giving additional equity). The changes in product and burn rate have put us on a path to reach cash flow positive before we run out of capital.
Preparing For Battle
In addition to the tactical changes in our business, the process we’ve gone through in the past three months has mentally and emotionally prepared our team for the road ahead. We know who we are and what we’re working toward, we’re aware of and very comfortable with the contrarian stance we’re taking, and we believe the long term opportunity is well worth the short term sacrifices we are making. As they say on Friday Night Lights, “clear eyes, full hearts, can't lose.”
I think Andrew Chen had it right when he said, "there’s always another move." If you’re the founder of a startup staring headfirst at the Series A Crunch and you can find the will to keep going, your job is to find that next move and make it happen. I hope to see more discussion on how companies are sticking with it and navigating the trough of sorrow. If you're in the midst of this process and need someone to bounce ideas off, drop me a note at @alanwells.