Operating During a Downturn #143
Reflecting on a few interesting reads and listens over the past week
Operating During a Downturn
As the market (specifically in the tech) continues to trend lower in valuation, we've started to see a lot of content geared toward operating in a downturn.
For both founders and employees, the past few months (along with the next 6-12 months) will be quite scary. Either you'll be working for a 'great' company that's well-capitalized and performing well or you're dealing with a high degree of uncertainty where you're not quite sure where your company stands and whether you'll be able to weather the storm.
As interest rates are expected to go up, the tune of investors shifts from growth at all costs to being able to grow profitably. 'Burn multiple' all of a sudden becomes top of mind.
Burn Multiple = Net Burn / Net New ARR
David Sacks from Craft Ventures has consistently put out great content when it comes to this topic - check out this post from 2020 and a more recent presentation that he shared with his founders.
I specifically wanted to draw your attention to how he looks at amazing/great companies vs. ones that are good, suspect, or bad.
In 2020, here's how David Sacks defined the varying levels of the burn multiple:
In May 2022, here's how his view changed:
Note that even for an investor with the track record of David Sacks, the goalposts have changed quite a bit. A burn multiple that used to be defined as 'great' is simply good and anything below what was previously 'great' is in the danger zone.
Looking at the broader venture ecosystem, it's fair to say that there are only a handful of companies that are truly great and can actually operate at a burn multiple of < 1. Most companies, especially over the past couple of years, have been conditioned to raise funds at a huge valuation under the presumption that they can always raise more whenever they needed to. This has led to poor habits/discipline when it came to hiring and ultimately led to employees getting more than what companies can actually afford to give.
The reality is that many companies are being faced with a 30 to 70%+ correction on their valuation - creating a scenario where they are likely not worth anywhere near what they last raised and many of them probably can't justify a valuation that matches the funds they raised.
Unless certain preventative measures are taken (e.g. creating an employee participation pool), most employees at companies in the 'danger zone' are holding options that are worthless (unless the company turns around) and face the risk of being laid off so that the company can increase its runway.
Outside of considering layoffs/hiring freezes, it's important to think about the fundamental problems. Here are a few common problems that David Sacks highlights (to reduce your burn multiple):
A gross margin problem — If the company spends too much on COGS in order to deliver the product or service, its burn will increase rapidly as it scales. If there’s not operating leverage in the business, the Burn Multiple will not improve with scale.
A sales efficiency problem — If CAC is prohibitive or sales productivity is diminishing, burn will increase relative to new ARR, causing the Burn Multiple to worsen even though growth continues.
A churn problem — Churn will net against the denominator of the Burn Multiple, causing the multiple to increase. A leaky bucket makes it hard to grow efficiently.
A growth challenge — If growth is stalling, the company may seek to compensate by spending more on marketing, giveaways, discounts, or promotions. That will be picked up in a higher Burn Multiple, as burn rises faster than new sales.
A founder leadership problem — If the founder lacks the skill or will to control burn, that will show through in the Burn Multiple.
Personally, an area that doesn't get talked about enough is the ability to move fast. Indecisiveness or a desire to make decisions via consensus can be fatal for the company (even if it feels like the right thing to do). Employees and founders should take an honest look at themselves and their respective companies so that they know what they're getting into over the next several months.