Serial Entrepreneur & Enterprise RIA Pioneer

Jeff Haynie

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The economic downturn and your startup

As everyone is aware, the global economic downturn is upon us and we’re all standing around trying to figure out what this means for all of us — especially us startups. I hope nobody is living in a bubble and believes we’re at the bottom and it can’t get much worse. My prediction, and plenty of others, is that it’s going to get much, much worse and last a lot longer than we can imagine. Maybe decades at this point, although that’s even hard to fathom.

The public markets are going to take a really bad beating and many companies, even companies with fairly strong balance sheets and business fundamentals, could find themselves in terrible terriority - either by a takeover or massive layoffs and cost reductions.

All-in-all, I do believe that this is a necessary cycle - part of the normal cycle of things. If you look at the chart for the past 30 years, we’ve been on the up and up for a long time. An overall correction is due.

DOW since 1970

DOW since 1970

I also believe that a large portion of the spiral is psychological. Nonetheless, the spiral will spin out of control for a good bit of time and we all need to be prepared. As a startup, you’ve got some really, really tough choices to make. Some are obvious, some are not so obvious. My advice would be to think long and hard about survival, forget everything you thought you knew a week ago and assume you’re going to have to get heads down and grunt through this. Even well funded startups are going to be in big trouble soon if they’re not careful. All your models, your predictions, yours forecasts and best guesses are gone. Throw them out and assume ZERO.

My advice to a startup that’s not cash flow positive right now is to assume ZERO revenue for 24 months. If you can’t survive right now with the cash you have in the bank for 24 months, you have a few options you should consider right now:

  1. If you have access to capital, get it now. (And assume you won’t get it)
  2. If you have access to debt of any kind, get it now.
  3. If you have anyone you can live without, get rid of them now.
  4. If you have outstanding AR, collect it right now - offer a discount or more product to get it in the bank.
  5. If you’re negotiating a term sheet, sign one right now - regardless of the terms.
  6. If you have a business line of credit, use it now.
  7. Look to cut as many fixed expenses as you can right now. Get rid of anything that is monthly if you possibly can — even consider the cost of breaking obligations short-term over the long-term cost.
  8. Look at your business and strongly consider simplifying everything you can.

If you’re cash flow positive, well, you’re in a different position but most likely have similar things you should consider (including above):

  1. Cut your 12 month forecast by 50%. IF you make it up, wonderful, you’ll be that much better. Assume that your customer is going to get killed as well and will be going through similar cuts and reductions and assume you’re on that list.
  2. Examine your bottom 25% of your sales force and eliminate it now.
  3. Take the top 15% of your sales force and consider changing the incentive plan — consider lowering bases (they’re already top performers) considerably and making it up for consistency of exceeding their numbers. Consider increasing your accelerators, but try to tie your accelerators (even consider compounding them) to consistency on a quarterly basis. If you do #1, you’ll be in an even better position.
  4. Reserve your cash as much as you can, you’ll be in a good position to sweep up around your market and get some of your competition on the cheap in the next 18 months.
  5. Don’t hire anyone unless you absolutely have to for the next 3-6 months. There is going to be top talent on the street soon and you want to have reserves to pick them up opportunistically.

I remember quite vividly the first dot com crash. I was in the middle of it and it was very depressing for a long time. This feels much, much worse and feels like it’s going to sweep much faster than even the dot com crash. Why? This is much more widespread - global even. Because of that, it’s going to hit all very, very hard. And each part of society will be affected, not just one sector or set of markets.

There’s a lot more qualified people out there giving some good advice this week. I received this internal letter (below) that Benchmark sent out to their portfolio CEOs:

The recent downtown in the public markets (now known affectionately as “the U.S. Financial Crisis”) is obviously on everyone’s mind. Some of the entrepreneurs and executives with which we are privileged to work have reached out and asked what this means for private companies, the VC world, and Benchmark. As such, I thought it might be a good idea to send you our thoughts on the current situation, and specifically what it means for venture backed companies.

From a high level, this downturn is different from the Internet bubble of 1999. First, the last downturn started in our backyard. We were the speculators; this time it is someone else. This means that the “crash on the beach” won’t be nearly as severe. In the Internet crash, many times the customer was actually another VC-backed company and as such, there was strong negative spiral. That said, while this downturn might be shallower than last; it could last longer in terms of absolute time. The American consumer is super-leveraged which wasn’t true before the 1930’s or the 1970’s. The overall economy will have trouble gaining momentum with this debt anchor, and my best guess is the contraction is not yet finished. As such, it might take a long, long time before we see glory days again.

Like every major shift in the environment, this one will offer opportunities as well as risks. JP Morgan was able to buy two great assets at substantial discounts with government assurances, precisely because they played the game frugally while others were more risk seeking. The real key is to have a keen understanding of the game on the field and to be the one that adjusts swiftly, rather than the one that moves after it’s become blatantly obvious to everyone else it’s time to move. Many companies that thrived post 2001-2003 were simply “Last Man Standing” in their industry. It doesn’t sound all that glamorous, but it was the exact right strategy to deploy at the time.

In terms of defining our current situation, let’s start with the impact on the actual capital in “venture capital”. The institutions (limited partners) that typically invest with Benchmark and other venture funds are not the ones on the cover of the financial news everyday. In fact, these limited partners are typically quite conservative and have a very long-term perspective. Certainly, new precedents are being set every day, so it’s hard to say the word “never” in this environment. Still, we are unaware of any situation where capital availability for us or any other VC firm is in question.

One would also expect across-the-board reductions in follow-on financing valuations. As financial markets deteriorate three things happen. First, investors get nervous. As such, they tend to “choke up on the bat” and be more conservative. We have already witnessed skittishness on behalf of follow-on funders, as well as a lengthening of the time it takes to complete a fundraising. The second reason valuations will fall is that the public market comparable valuations have fallen materially. This will have a direct impact on exit prices, be they an eventual I.P.O, or M&A. In fact, I was recently at a gathering of corporate development execs, and their number one concern was that private company executives have not realized that the scoring system was just reset (expectations too high). Lastly, investors are more concerned that a protracted economic downturn will negatively impact each private company’s specific results, increasing the likelihood of a revenue or cash flow miss.

If we leave you with one message it would be this: financings as we know it just got a whole lot tougher. Basically, the cost of capital is going way up. This is, of course, a sweeping generalization. Some of you have tons of cash, and some of you are profitable, so the immediate impact will obviously be less. That said, if you do need to go to the market for capital in the foreseeable future, you should consider that the environment will be much less hospitable than it has been for the past 3-4 years (which have actually been pretty benign), and that this less hospitable environment could first for time measured in years not quarters.

Another obvious strategy is to extend the runway. Hopefully, everyone is aware of exactly how many “months of cash” they have at their current cash level and burn rate. If you have a method for increasing this runway, we think you should do it, and quickly. This serves two purposes. First, it gives you the opportunity to outlast the competition, and second, it puts more time between now and when you are forced to re-enter the capital markets. One could argue you should draw down your bank lines right now. Why? When you need the money, the funding source may just say no (they did last time). What are you going to do? Sue them? Take away their warrant coverage? So what. If they get cold feet - you won’t see the cash, I don’t care what the term sheet says. The bottom line is that you should watch “months of cash” as your most important variable.

Be calm, but pragmatic. The purpose of this letter isn’t to send everyone off in a panic. It’s simply to convey that the rules of the game have changed. One key problem is that during these market downturns, most people don’t adjust quickly enough. As an example, not hiring heads that were previous TBH isn’t really a reduction in expense. Also, 10% cuts rarely lead to anything other than multiple rounds of cuts, which have a harrowing affect on culture. It’s easy to mentally understand this is the right thing to do. It is ten times harder to make the actual decisions to affect change. These are extremely hard decisions.

You may know that I am involved in Zillow. They did a survey of their users to ask what they thought was the current impact on home prices across America. The average answer was that homes in America were down 20-30% in value. The survey then asked what the user thought had happened to the value of their own home. Miraculously they thought their own home had retained value against the odds! Surprised? It is human nature. As most of you read this, you will be thinking in the back of your mind why your company is different than the average company (like these homeowners) and why you are the exception that doesn’t need to take action right now. This could be rationalization.

Recently, I spoke with an entrepreneur who as CEO during the dot-com crash and oversaw a headcount reduction from 130 to 28 (through two major layoffs), and eventually back to profitability and an IPO. If you think a 10% layoff is tough, imaging laying-off 78% of your employees. It is one of the hardest things I have ever seen anyone do. I recently asked him how that experience has shaped the way he would advise people on running a startup. He had a list at the tip of his tongue (included now):

1. You don’t realize how fast things spin out of control. There are self-reinforcing negative effects in a downturn.

2. Don’t spend money until you have to:
a. Don’t move out of your office until you are sitting on top of one another
b. Don’t hire any incremental employee until you just can’t stand it
c. Don’t get more capacity in your data center until your site is going down

3. Better to be “late to the party” than to be early and run out of money

4. Line item review of the budget every month (legal, accounting, everything)

5. Not just a CEO mindset, but a company mindset:
a. Everyone must buy in to the process
b. But in a calm way - not run for the hills

6. Create 2 or 3 different burn scenarios - know at any point in time how many months cash is left

I include this mainly because it highlights a “very high bar” in terms of frugality. It’s one thing to say you don’t “waste money” and another to live as lean as you possibly can. As mentioned before, in market downturns, frugality is not only a virtue, but also it could be the difference between survival and failure.

Many great companies emerged from the 2001-2002 time-frame. Companies built during tough times typically have incredible focus, great cultures, and true desire to compete and win in all environments. For many, this downturn period could be opportunistic: a real chance to differentiate yourselves from the other players in the market. However, it is imperative to understand that the environment has just shifted to one where differentiation will likely be defined not be aggressiveness, but rather by adaptability.

Folks, the game has changed. Time to get serious, get focused and sober up. The world’s going to be a much different place for awhile. And, I sure hope we’re all much better off for it in the long term.

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Jeff Haynie is co-founder and CEO of Appcelerator. He started Appcelerator to provide a true open-source solution to enterprise RIA and SOA-based services development, after growing frustrated by the limited options and complexity in other solutions through his own development work. Prior to starting Appcelerator, Haynie served as co-founder and CTO of Vocalocity and CTO of eHatchery, an extension of Bill Gross? ideaLab. Haynie is an expert software developer and entrepreneur. Haynie has been active in standards development, as well as a contributor to open-source projects, including early work on JBoss. For more on Jeff Haynie, visit his blog at http://blog.jeffhaynie.us.