The OR versus the ER
Startup survival methods in two different operating environments
As we enter 2023 there has been a guiding theme in many conversations that we’re having and that is, “how do I do more on less?” This requires a mental shift from what I might call “abundance mentality” to “resource-constrained mentality.” For anyone who might recall the story of Apollo 13 and the less-than-optimal pile of duck tape and cardboard from which Commander Jim Lovell and crew had to make an air filter to convert CO2 out of scrap materials to stay alive, this is 2023 for many startups.
I too have been there, many times in the trenches. I’ve gotten the elated email saying “we’re in for $3M” and also the midnight note when cash is out and we might have to let everyone go by 5pm tomorrow or run the risk of being in fiduciary breach, conference calls with law firms costing you money you don’t have, and trying to bridge a company to acquisition out of the executive team’s pocket. As anyone knows in startup land, there are extreme highs, and also extreme lows of self-doubt.
There is a dream of unlimited capital where your desired hires, desired salary, and desired months of runway to perfectly de-risk the business reverse engineer the target fundraise, and you back out valuation by dividing your target fundraise by 15-20% dilution. This is abundant living, and these days are on hold for now. Of course we’ll all read about some serial founder’s new company that we didn’t know existed that just closed a $40M Series A pre-product, but that’s not me, and that’s not most of us. For most of us we need to shift gears into “resource constrained” mentality.
Logic of Abundance:
I need to prove out X, Y, and Z to de-risk my business
In order to do that I need to hire people, and build for 18 months
The cost of those people is $100k/month so I’m raising $1.8M
I’ll probably just oversubscribe to $2M and do it at $10M post
That’s a nice round number of 20% dilution I can sleep with
Resource constrained logic is our new paradigm. This is the reality in which you don’t get the perfect oxygen filter and burn time to take the spaceship home. Instead you have a pile of cardboard and duck tape and 14 seconds of fuel to burn to put the spacecraft on the exact trajectory, or you’re going to bounce off Earth’s atmosphere and hurtle endlessly into space. This is the world of Apollo 13 and imperfect solutions, and you need to figure out how to make it all work without all the right parts. Nearly always, something pretty major is missing, both in pre-seed investing, and in pre-seed company building. It’s about making it work in spite of missing pieces. This new world is one in which investors remain on the fence waiting for a lead, where some Zoom calls result in “come back to me when you have more traction,” or “we actually only invest in [insert one of 1,000 made-up excuses].”
I need to prove out X, Y, and Z to de-risk my business
In order to do that I need to raise as much money as I can
Let me A/B test various fundraising strategies holding constant the amount of acceptable dilution, but varying amounts of capital. For example if I can only circle up $750K of interest, and investors are willing to price this at about 15% ownership, then the post-money cap on my round will be $5M.
I need that $750K to last me 18 months
Therefore my burn rate can be 750K/18=$41,666
I need to figure out how to run my business on $41K net burn rate / month. If this is utterly impossible then I need to go back to the drawing board and accept more money and more dilution. Or I need to generate services revenue such that perhaps my gross burn can be as much as $60K or $80K but I’m offsetting that net burn with $20-40K of revenue per month. These are my options.
We have phrases such as “down round” or “re-price” that scare us, but they need not alarm. When these words come about we’re likely long past preventative medicine or even the Operating Room where we get to control every aspect of the surgery and make sure every stitch is perfect and every wound dressed. We are now in the Emergency Room where the operating principles are different. In the ER it is about survival, about triage, about staying alive no matter how messy it all gets. The guiding principles of the ER are very different than that of the orderly OR. If 2023 is a challenging year, and we know that going in, we all need to be asking the tough questions earlier to take preventative action, and make decisions while in the OR that might not be perfect, but they save us from going into the ER where we have less choice. The main challenge of 2023 is take proactive steps, and don’t do it alone. Involve your cap table. Call your investors. Ask for help. Lean into your network.
Founders sometimes tell us, “I’m unable to raise money.” Raising money is a function of two things 1) traction, and 2) price. If you can’t expand your reach to show sufficient traction fast enough, then the other lever you can control is the price. When a founder is “unable to raise” at a $12M valuation, the answer is simple; lower the price. If investors aren’t biting at a certain price, simply reframe the ask. Terms like “down round” sound bad, but all you’re doing is trading off an amount of dilution for an amount of capital, so don’t get hung up on the sticker price. It’s about getting great partners around your table, and doing so in a way that preserves as much equity as you can while raising as much money as you can to extend your runway.
A doctor warning a patient to take care of themself and be careful hopefully keeps patients out of the OR, and especially out of the ER. Preventative medicine is important and so is transparency. The world has changed over the past twelve months, and it will continue to change over the subsequent year or two. The deeper we all internalize these messages and heed caution, the better prepared we can be to act in whatever environment comes about, OR or ER. We are all living in various incarnations of the Apollo 13 capsule where the air filter will eventually fail and there is limited fuel to get home. It’s how we manage this that keeps us alive. In this new paradigm make sure you check the health of your business, involve others, ask for help, and practice preventative medicine such that you stay off the Op table. By the time you forgot to share investor updates and you’re three months from cash out, you’re already in the urgent care, and it’s going to take life support to stay alive. 2023 is the year to look out ahead and don’t be afraid to ask for help. Take action.
Scott Hartley is Co-Founder and Managing Partner of The Fund.