Surviving The Cash Crunch (Part 1)

Photo by © 2008 Daniela Hartmann

You are 3-6 months away from running out of cash.  Your current business model & strategy isn’t going to make it happen over that same period.  You are unable to raise a new round.

This is another classic stage for mid-stage startups I’ve heard nicely referred to as “controlled burn”.  You either need to pivot onto something new or give your current strategy time to break-even, whatever it is you need to do, you don’t have the cash to do it without doing something about costs.  So you need to turn 3 months of money into 12 months of money or more.

I’m speculating, but the number of start-ups who hit a cash crunch over all-time probably approaches infinity.  Annoyingly though it doesn’t get written about often and there isn’t a lot of useful advice I’ve found.  Having seen this a few times and talked to a many companies with this type of problem, I thought I’d try and touch the topic with some useful tactics.  One key note – all of this needs to be done in advance of running out of cash, not once you have run out of cash.

Do NOT Raise Too Much Money, Too Early

My first advice is preventative.  I’ve been part of teams that have raised $0, $80mm and $20mm as the initial round.  So I have some very real world experience with both ends of this argument.

Photo by Stephen Poff CC BY-NC-ND 2.0

There are two problems.  The first is that if you raise a lot of money, your investors expect you to do something with it, not sit on it.  You are expected to get “fat”.  Hire a great mgmt team, hire middle mgmt, hire depth, have project managers, have tons of software firepower, big marketing plans, big markets, etc, etc.  This means that your burn will probably be stupidly high and you’ll probably hit cash flow problems marginally past that of a team that raised much less capital.  It means your cuts are more painful and the “paradigm-shift” is larger.

On the other side, you eliminate options for handling cash flow issues by raising too much, too early.  Imagine each $5mm increment as chopping off a tier of the investing market for your company.  Somewhere past say $20-$30mm you need to have the financial results to match your valuation to enter into these new “investment markets”.  You can end up pigeon-holed into a tiny corner of the investment world – need lots of money, have a great team/idea, but don’t yet have the results to justify the results…. uh oh.

This is where founder-killing down-rounds and inside-rounds happen and equity disappears.

Layoffs

For most startups, the biggest cost is people.  If you want to control burn, there’s probably no way to get around dealing with this.  So here’s a few ways to actually bring down people cost:

1. Cross the board pay cuts – CEO goes to $1, mgmt team takes large cuts, staff take smaller cuts.  Keep the team together.  (Usually you talk yourself into this strategy because you have like a half a percent chance at having some big company who you’ve met once buying you)
2. Big layoff day.
3. Offer packages, options to furlough or take time off – “anybody want to take 6 months off to travel the world and want to come back to a full paying job?”

Generally, I’m a fan of cut deep, fast and once.  If you try to be the “nice guy” and retain people for less money, etc – you are screwing everybody.  Many employees will get a new job before your notice period ends and it’ll probably pay more than they made now.   You are not being nice by offering them a chance to stick around at reduced pay.  Others have big enough bank rolls to live without income for a bit and will take time off and deliberate about jobs – e.g. senior mgmt.  For some, layoffs are common territories – for instance accounts and analysts, often the first to go as they are nice to haves, not must haves in a cash conscious company.  Other folks will use this as the impetus to do their own entrepreneurial adventure and will get rich because you laid them off.  So really, don’t get all teary and sad about laying folks off – many will be able to handle it and you aren’t doing them a favour by keeping them around.

My “nice guy” layoff tactic would look something like this.  Do all your layoffs at once and give a reasonable notice period (4-8 weeks??).  Don’t spend much time deliberating and talking to folks – morale dies quickly and people stop working when waiting for a decision.  Do it and make sure to do it deep enough the first time.  Then, go out and help the people you laid off find new jobs.  Reach out to your vast startup network – for every startup laying off, you can probably find a new one hiring, especially folks with startup experience.  Then, give some time, say 4-6 weeks.  Then and only then, if some folks seem to be in trouble financially and unable to find work – offer them contract work to get them past the hump, a few grand a month, something like that.  Double down in helping them find them new roles.  Ask your VC for help in placing them.

Partners & Creditors

Before I write what I am about to write I want to make some things very clear.  Always do honest business and never screw your partners intentionally.  Your name is everything.  When you are starting to get short on cash talk to them and look for options, some will have experienced similar and will be helpful.

So my first advice is preventative.  When you negotiate every contract, take it from the lens of “what happens if I run out of cash?”.  Can you terminate?  Can you adjust pricing?  Are the terms 30 days or 90 days?  Can they kill my business if I am short on cash?  Don’t bet on a long future and sign-up for 2-3 year deals.  Business flexibility is probably more important than scaling costs downwards off the bat.

Once you are in the cash crunch situation, here is a golden rule I once heard “Pay your customers, not your creditors”.  I.e. in a world of limited money and limited choice of how to apply it, remember that paying creditors won’t result in your business generating cash,  it will result in your business dying and all your creditors getting $0.  You are helping your creditors by helping yourself (presuming you don’t spend it stupidly).

The key date to remember when negotiating with any partner is their fiscal year end.  If you are past 90 days due on payments, you have to pay something otherwise your partner is basically forced to write you off as bad debts.  If you pay anything, they can keep it as revenue.  Also remember that if you have global partners that standards of non-payment are very different.  Payables past 90+ days may be more the norm than a “business faux pas” in certain countries.

No matter what this is going to result in you hating your job for a while.  Negotiating and settling with partners is not fun.  Nor is stringing out payments.  People will not say very nice things to you.

In part 2, I’ll look at customers & pricing, and operating your business once in the cash crunch.