What to Do if your Startup is about to Fail

A lot of CEOs with less than 12 months of capital left have been asking me for advice about what to do, given the massive economic turmoil we're facing. I thought I would take the time put these various conversations into one email to help those who are "up against it," as we say in Brooklyn. Rock out To This While Reading: Don't Stop Believing Forward To: Startups that are hitting the wall Now, sprinting to the startup precipice is one of the most horrible and exhilarating experiences you can have as an entrepreneur. The exhaustion sinks in as you slam on the brakes. You dig in your heels and watch the dirt and pebbles fly off the cliff as your left foot dangles down in the ravine, with your right foot desperately trying to save you. Your momentum could--if the wind kicks in--send you straight down to your death. Heck, even the two inches of earth under your right foot could give way and send you to your death. Or, you could slip and fall on a magic carpet that will take you to the Promised Land. OK, that last part is made up. You're probably screwed and you know it. This email is intended for startup companies with less than 12 months of cash in the bank, who know in their hearts that their VCs have lost faith, and that Google, Yahoo or Microsoft aren't going to pick them up on a magic M&A carpet ride. This is the email I'd like you to forward to your friends who are running startups that could go under in 2009. Some background ------------------------- I've been to the precipice and faced the fall a couple of times. I've learned a couple of things from the experience. I can tell you that the first time it happens, you're terrified, because everything you've done--all the effort and dreams--will probably be lost (like tears in the rain). The second time it happens, you're deeply concerned, but know it ain't over until you're splattered on the boulders below. The third time it happens, you smile and say "let's get it on!" You see, there are two types of entrepreneurs in this world: real ones and the folks who play entrepreneurs for some portion of their lives. >From a distance, most folks can't tell who's who. In up times, when the market is flush with cheap money and unexplained exits (Bebo, anyone?), everyone looks brilliant. It's only when the tide goes out that you know who's naked. (Who said that? I hear it on CNBC every other week now). The differences between the two types of entrepreneurs become clear when the fan and the manure meet. The faux entrepreneurs run for cover rather than dealing with the storm. They go back to their plush, somewhat mindless jobs as VPs at mega-companies, while the real entrepreneurs suit up and clean up the mess. We're going to find out who the real entrepreneurs are in 2009 because they are going to spend another 12 months, on top of the last six, cleaning up the mess. It will be two years of total pain, so before we go any further you gotta make the decision if you're in or you're out. In or out? ------------------------- Here is a really easy way to figure out if you can deal with the mess in front of you. How many of the following can you deal with: 1. Laying off half your staff. 2. Laying off half your staff again three months later. 3. Spending 20 hours a week on the phone being yelled at and threatened while trying to renegotiate a dozen contracts--like your T1, phone system, rent, equipment leases, etc. 4. Having an investor scream at you and tell you that they will ruin you, your career and that "you'll never raise money again, you mother f-er." 5. Laying off half your staff for a third time. 6. Getting served a half-dozen lawsuits, courtesy of the folks who you tried to renegotiate with in point number three who wouldn't deal. 7. Having one of the people you're renegotiating with come to your office every week and ask for their check in person. 8. Having the same media outlet that once claimed you were the next Barry Diller write that you're a fraud. 9. Not getting a good night's sleep for six months. 10. Having dozens of paying clients default on their bills. 11. Having staffers who you really need to double down and focus walk out the door after you helped make their careers. 12. Have the people who begged you for a meeting at the peak not even return your emails or phone calls. If you can't deal with these 12 situations, then you're out. It's time to refresh your resume, tell your board you resign, sublet your place and go to Thailand. Go sit on the beach and lick your wounds for $40 a day (all-in) like the fauxtrepreneur you are. You suck. I hate you. You're smart enough to cut your loses in a way I could never understand. If you think you can handle most of the horror above, well, then you're in. How do I know this? Those 12 things--and more--happened to me for over a year when Silicon Alley Reporter, my first business, got whipsawed by the dotcom bust. We went from $11.6m in revenue one year to $600k the next. From 70 full-time people to 12. From a 20,000 square foot office to subletting ten desks at a PR firm. Personally, I went from being on top of the world, with appearances on Charlie Rose, 60 Minutes, CNN, and Fox News, to being savaged in the press as a fraud who got lucky and who no one would ever hear from again. My office used to get 100-200 phone calls a day and I had two assistants. Six months later, I answered my own phone--on the rare occasions it would ring. When it did, it was either my mom calling to check in on me or a vendor calling to yell at me. It was the worst year of my life, but it made me who I am today. I've never talked about the tailspin that my business went into, and how I barely managed to land the plane, but I get the sense that there are a lot of twenty-somethings about to experience the same thing, and perhaps my lessons could help. I'm not going to tell the story. (That would take 80,000 words, a hard cover and the right publisher), but I'm gonna share some of the lessons. Let's get to work. The Good News ------------------------- If you're a real entrepreneur, you're still reading. If you're a faux entrepreneur, you're writing your resignation letter, considering which beach to surf and how long to grow your beard. God bless you fauxtrepreneurs, because you're gonna have a much nicer 2009 than the real entrepreneurs who are "up against it." Of course, a year from now, the real entrepreneurs will be battle-scarred beasts who are capable of taking big bold risks, and you'll still be crying about what could have been with your last business while attending back-to-back meetings about nothing at BigCo. Not that I'm judgmental of fauxtrepreneurs who create noise, distract investors from the real workhorses, suck at their jobs and take no real risk in their lives. No, on the contrary, I love you fauxtrepreneurs, because you create the foundation upon which real entrepreneurs stand. At the start of my career, it wasn't east to stand out, but by the time I'd done two or three businesses and become a fixture in the technology industry, I had figured it out: Longevity is a big part of credibility. I met Esther Dyson, Fred Wilson, John Brockman, Jerry Colonna, Mark Cuban, Ted Leonsis, Seth Godin and countless other luminaries between 1994 and 1997. Well, it's a dozen years later and they still take my calls and respond to my emails. Longevity is credibility. Oh yeah, I almost forgot the good news: People's reputations are made in the bad times more than the good times. Even if you're 100% sure your company is going to crash in the next six months, you'll learn more from staying on board than you will from running. You'll also earn the respect of your peers and you'll learn exactly how people break down and lose their cool. You'll see how certain VCs screw entrepreneurs, you'll see entrepreneurs screw VCS and you'll watch the lawyers and landlords collect their vig the entire time. Most of all, you'll realize who you are and who your real friends are. So what's the sitch? ------------------------- You need to figure out your runway immediately. This is really easy to calculate: you look at how much cash you burn every month and divide that into how much cash you have in the bank. Your accountant can do this for you or you can simply look at your P&L and bank statement. Once you know how many months you've got left, you've got to do the hard work of trying to extend it by at least 1/4. This means cutting staff, negotiating with your landlord and cutting any and all recurring bills. You then need to look at your revenue streams and figure out if you can double them. In most cases, if you do these two simple things, you will have increased your runway by 50-100%. If you double your runway, your chances of figuring out what your business actually is will go up exponentially. You also need to do a monthly P&L review with your management team. Look at every single recurring cost you have and figure out how to cut it. In an up market, this level of obsessiveness is often wasteful, because you're in a race to take market-share. In the case of MySpace vs. Friendster vs. Facebook all having unlimited funds for a period of time, this makes total sense. Why worry about $100,000 in server costs if you're racing to see who gets bought for a billion dollars first? However, this is not that time. You have to change your style. There are times to hit the gas and there are times to conserve your gas. Look at it this way: Getting the most market-share and running out of cash is the equivalent of getting to the moon first without the ability to get back to Earth. Congratulations, you won the race... and now you're dead! My primary business right now, Mahalo.com, is lucky to have raise a large amount of capital and is going to fairly easily make it to profitability based on our growth curve, runway, modest spend and significant traffic (we're at 5.6m unique visitors over the last 30 days). We couldn't be in a stronger position. However, even we recently did a deep review at Mahalo and were able to cut 30% of our costs in under 60 days. The company is still growing just as fast, and in fact we're actually more efficient. There is something strange about that: 25-person companies seem to get more done than 40-person companies in my experience (other CEOs have told me the same thing). Perhaps it's because after you trim down you have the most efficient folks left, or maybe we're all more focused because we don't have to communicate what's going on to as many people? Does anyone know if there is any research on optimal team size for startups? I'd be interested to hear what the studies say. Anyway, we made the hard decisions and that extended our runway by a year. That means Mahalo will be here in 2013 if we make every single wrong decision and we're asleep at the wheel. Of course, we're focused like lasers on getting to profitability and developing a really helpful service. If we can't figure this business out by 2013 or 2014 then, well, either we really suck or there is no solution to combining search and knowledge exchange (of course we know search and knowledge exchanges can and have worked--so we're bullish). Also, when your company goes through this kind of economic boot camp, I think you get stronger. You understand which parts of your business are working the best and which ones are, well, not working at all. We had one area of our business that was two percent of our spending making 30% of our revenue. You figure these things out when you start cutting. It's a sick and sad process to be sure, but Darwin is your friend at a startup. Put your VCs to the test ------------------------- If you're running out of money, you've got three choices: cut costs, make money or raise capital. We're going to get into cutting costs and making money below in a minute, but I'm a big fan of testing your investors. When the market is crushed, most VCs get realistic, greedy or paralyzed. You've got to figure out where you stand with your current investors as quickly as possible, and the quickest way to do that is to ask them for more money. Let's say you're burning $200k a month and you have a million dollars in the bank. Go to your VCs and say something like the following: "John, we're going to run out of cash in five months. I've developed a cost-cutting and revenue-generating plan that I believe will extend our runway to 10 months. I'd like to present it to you and your partners tomorrow for a half-hour with the goal of doing an 'A+ round' of one million dollars. I truly believe in this business and I'm willing to do a flat-round, bust my ass for the next two years and come out of this recession on top." Now your VC is probably going to start asking questions--as they should. They may try and push off the discussion of the "A+ round." Your job is to stand firm and say something to the effect of: "Well, we're both vested in this business and I'd like to take the time to present to you guys this week and get a response from you either way within five days. I know it's a compressed time frame, but we're living in extraordinary times, and if you guys don't believe in the business the way I do, I can accept that and make other arrangements." At that point, you say nothing. Silence is the greatest negotiating tactic ever created--use it. Your VC right now will be thinking the following: a) "This guy/gal's a real killer and I wish all my CEOs were this focused. At the very least, I should hear them out." b) "This guy/gal has another opportunity, so I'm gonna have to deal with this train wreck myself--that will suck." c) "This business is a dog and I shouldn't have invested in it. Since they're asking for the truth, I might as well give it to them." d) "I'm an idiot and I can't make decisions. Let me push this out a couple of weeks and make this person's life hell while I procrastinate." That last part is not what the person would actually say, but that's basically the translation of "let me think about it." Now, in cases a, b, and c you're in good shape. You're gonna either get your meeting and money or you're gonna get told you're not getting any more funding. Situation D is what you don't want. If you're running out of provisions in the middle of the Atlantic, your best bet is to go either East or West--not in a circle. VCs and investors will sometimes send entrepreneurs in circles, either inadvertently or as leverage. Sometimes VCs are juggling a lot of balls and can't focus. Sometimes they're inexperienced and/or they have issues that don't concern your business, like their limited partners, their partners or their divorce settlements. Sometimes they're cutthroat and know that, when you're down to your last two or three payrolls, they can extract a 2-3x liquidation preference out of you. It's your job to force the issue now--don't wait. Heck, even if you have a year's worth of runway, you should probably do this kind of thing so your VCs know you're the real deal and so you know where you stand with them. Put your staff to the test ------------------------- If you're down to six months of cash, you're gonna have to cut the bottom 1/3rd of your staff, if not half. This sucks, but there is no choice. You're gonna also have to cut salaries. So, here are some suggestions on how to do this: 1. Get rid of the non-core staff. Look in places like PR, marketing, and admin to cut. See if you can put some of these folks on part-time. 2. Look at the salaries of your current staff vs. market and look for ways to cut the high-priced ones who you can get cheaper at the current market. I know this sounds cutthroat, but remember, this is advice for folks going out of business in six months. Another way to run this test is to ask yourself "Would I hire this person for this amount today?" 3. Go to each member of the team who is over-paid by today's market rate and tell them that you're probably going to be cutting their salary and that you're increasing their options. Ask them how they feel about it. Some people can take a pay cut, others can't--you don't know until you ask. I'm really against cutting people's pay above cutting position because you want the people remaining in your organization to be happy. Of course, sometimes that's just not realistic. Many CEOs overpay in a hot market because they feel they have to, and those folks are the ones who really need to take this hard action now. Put your landlord to the test ------------------------- Call your landlord and ask them to get a cup of coffee. Do this in person. Let them know that it's 50-50 you're going out of business and that you need their help in the form of four months free rent, starting today, the ability to sublet some space (if you don't have that right already) and to keep the rent at the same rate you already have. Tell them you feel horrible about this, and you wouldn't ask them to do this if it wasn't urgent, but you didn't want to drop the bomb on them five months from now when there were no more options. Remember, silence is your friend. Tell your story and see what they say. I did this at one point and not only got free rent, I got 50% of our letter of credit freed up. It was a win-win. Trust me, your landlord is probably facing a LOT of fallout right now... better to get half than nothing. Put your vendors to the test ------------------------- Since you've probably got webhosting, CDNs, equipment leases, and other recurring charges on your credit cards, cancel those cards immediately. Call up each vendor and tell them you need six months free while you figure out your status, and if they can't do it, ask for suggestions. Then call each of their competitors and let them know that you are willing to switch over for the first six months free. If you get one of four vendors to do this you just saved 25%--I bet you can get two or three. Vendors would rather eat some profits for six months than lose your business. If they can't support you in your time of need, then you should find someone who will. There is a LOT of competition out there and you can negotiate harder than you probably think you can. Tell vendors you're willing to switch if they give you six months free and see what they say. We've had folks offer us a *year* of free service to switch (of course, that's an exception, not the rule). Put yourself to the test ------------------------- If you're going to ask so much of your staff, investors and vendors, you obviously have to take a hit yourself. Go to your VCs and ask them to participate in the next round--the A+ round. Tell them you know it's not a lot but you want to put in $5 or $10k in the round as a show of support. This will result in them saying it's not necessary. After that, tell them you'll sell your car and take a bike to work and put $20k into the business if you can get that for your car. Make sure your staff doesn't take a bigger cut than you do in salary if you're doing salary cuts. Even if it's just ceremonial, it means a lot to make cuts. I've stopped traveling as much to conferences even though they cost me little to nothing (normally people pay me to speak or at least pay for my travel). Of course, don't cut traveling if you're going to conferences where you might find clients or investors (which is why I travel half the time!) Put your product to the test ------------------------- As Mark Cuban told me over and over again, "Sales solves everything." If you can't sell your product, it's not a product--it's a hobby. Take your consumer service and sell it as a software package to someone. Go on the sales calls yourself. During the final year of Silicon Alley Reporter I made cold calls and set up lunches to sell folks on our new product, Venture Reporter (the rebranded Silicon Alley Reporter). It works. When people see the CEO making sales calls, they respect the company and take it seriously. When the VCs and staffers see you doing this, they get inspired. Put a whiteboard up and count any stat you can: sales calls made, meetings scheduled, contracts sent and sales closed. Give your team something to think about other than just the bottom line, because you might have to celebrate the little victories before getting the check in the door. Celebrate getting the meeting. Celebrate sending a pitch out. What to do if it's over ------------------------- If you're going to hit the wall, you should do so with three or four months of capital left in the bank. You should cut down to your core staff and tell them "we have 120 days of cash left and we're going to try to land the plane safely. If you want to leave at any point during the 120 days you'll get the reference of a lifetime from me. If you help us land the plane safely I think we'll all be better off because of it." Then make a plan to do one of the following: a) sell the business b) close the business c) sell the assets of the business There's a little bit of overlap up there, since sometimes you close the business and sell the assets, or you sell the assets and leave a shell behind. The point is, don't wait until you have a month left. Do it when you have 120 days left. If you signal to everyone it's over, you'll have done the honorable thing for your employees, by giving them the maximum time to have a safe landing, and for your investors, by allowing them to roll the business or its assets into another company. The worst thing to do is to delay this process. I've gotten down to this point exactly, but when I was at break-even at my first business, we looked for a buyer, because I didn't think we had much chance of making it on our own in the 2001-2002 market. I could have been wrong about that in retrospect, but either way, I'm glad I got out because it set me up for Weblogs, Inc. And that is the final lesson: when one door closes, three more open up. When you shut down your business properly, you will have a clean slate and renewed energy to take on your next project. You might even get the investors to give you the company with the 90 days worth of capital left to start your next project with a recapitalized structure. Remember that there is no shame in failure but there are honorable and dishonorable failures. If you're going to lose the game, remember that it's just that: a game. There will be another and another and another yet to play. Don't lose your cool and don't get depressed. Just get yourself back up, dust yourself off and get back in the game. The precursor to success is almost always failure. [ To the 17 folks who made it to the bottom: If you're struggling with failure right now, if your business is failing and you don't think you can go on, remember that at the very least you've been lucky enough to take your shot. That's more than most people get. You're going to be much stronger for getting through the heartbreak of a failed business. Also, you've always got me--your pal Jason--if you need a shoulder to cry on. I'm only an email, tweet or IM away jason@calacanis or jasoncalacanis on skype/twitter/AIM. ]