Startup Blood Bath – What a Recession Feels Like

Today looks like a bit of a blood bath on the markets, so I figured it is as good a day as any to talk about what an economic downturns feels like for startups. I was “fortunate” enough to launch a company the day Lehman collapsed in 2008 (Sept 15th!!), and got to see the first hand impact of the downturn. We also were raising a B round during that time.

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Most media seems to paint the picture of this post-apocalyptic world where suddenly all funding disappears and everybody wakes up and the tide has gone out and everybody is naked. I disagree. To me, the downturn felt more like death by 1000 paper cuts, such as:

Your churn will climb. Partly because of non-payment, failed credit cards, canceled credit cards, etc. If you do churn reports, “cutting back” and “not feeling the value” will increase as reasons.
Suppliers/Partners will stop paying you in a timely way, some never. Your average AR period will start to run at first slightly longer, then much longer. You’ll probably need to hire a baseball bat.
If you have physical product, distributors/channel will send back inventory because they are getting rid of any “risky” inventory and focusing on basics, i.e. products & goods that move easily like toilet paper and milk.
Conversion rates will start declining for every marketing trick you try (except lowering price). And with that, cost of acquiring customers goes up. You’ll also probably just invest more into marketing as an initial reaction to declining customer counts.
Your ISP (or any low margin, commodity supplier you use) gets “acquired” by 3 different entities in 12 months and start having annoyingly regular outages.
Angel investors, or anybody holding debt, turn into vicious debt collectors. As terms reach they demand outrageous interest. Now you are paying 2 employees worth of interest per month.
You are forced to lower price, at first by small amounts, and then gradually more.

So if you increase churn by 2%, increase acquisition costs by 10%, chop price/revenue by 10%, do you know what you have???

A Broken Business Model that is Not Fundable.

More good news, VCs and angels get caught in this churn. Exits disappear (2008 VC backed M&A was down 54% from 2007!!!) and with it RoI. Many “busted business models” appear in the portfolio, and soon they have to get written off. It gets nasty. VCs who are dying stop feeling like the Fred Wilson-ian brothers-in-arms company builders, and they start to feel more like debt collection agents. SELL YOUR COMPANY! MERGE WITH THIS CRAP COMPANY! LETS PARACHUTE IN A NEW GOLDEN CEO! PAYCUTS! WHY ARE YOU GUYS GETTING PAID?

The Good News

Here’s the first good news. Only two things on the planet can force you to die: 1. YOU – You Give Up & 2. Debt Gets Called.

The second piece of good news. Some businesses do great at managing downturns. Why? Execution and a little luck. You can track all the little death by a 1000 paper cut stuff I listed above, see that the world is changing and manage it. If people stop paying you or start delaying on payments, you gotta get out there and do some hard nose collecting. If churn starts to rise because of credit card defaults, try to bill in new ways – use different billing dates, bill in multiple smaller chunks, etc. If you have to lower price, get a new product out or a range of products so you can defend average price. If you see it coming and are fast enough, you can react and your company can survive.

The third piece of good news. All of this starts happening before big market moving catastrophes happen. Bad “paper cuts” were happening months/weeks before Lehman collapsed. In the summer of 2008 other startups I knew were having churn & credit card payment issues.

There are a lot of folks who survived 2008/2009 and built profitable businesses around Canada. Would love to hear some of your thoughts.

Startup’s Razor

Here’s is a lesson I (almost) learnt the hard way.

Back in 2006, I met a talented developer who had built a novelty web telephony product. We caught up for a tea and discussed applications for the technology. One ambitious idea was to create something akin to Yahoo Pipes with the Asterisk open source PBX. Pretty awesome, right?

With one developer and one designer we got started with a simple proof of concept. Then he broke (and almost lost) his leg snowboarding – out of commission for months, the project got dropped. Had he not wrapped his leg around a tree, in retrospect I am fairly certain the project might still have been left in the dust… read on.

There is a principle known as Occam’s Razor, which has been tabled by many great minds. It goes something like this:

Frustra fit per plura quod potest fieri per pauciora. – William of Ockham

Make things as simple as possible, but not simpler. – Albert Einstein

Keep it simple stupid. – Kelly Johnson

Fast forward to 2009, along came Twilio, an IP telephony platform exposed as a service via a simple API (it rocks, check it out). Fact: an API is far less complex than building a drag and drop pipes type solution.

The simplest solution, all else being equal, wins.

Why? The simplest solution is fastest to implement (aka Minimum Viable Product). The simplest solution addresses the broadest possible set of customer use cases. The simplest solution leaves the most capital to direct into the drivers of growth other than product development.

Can your product be too simple? Can you cut too much? Sure. That said, I’d bet you need to keep shaving (we did).

How to pitch to corporate VCs

One way to segment the world of VC is into two camps: (1) financial investors and (2) corporate investors. My guess is that a lot of the VCs lurking around here are what you would call financial investors; meaning, they take other people’s money, invest it in start-ups and try to make more money.

But there is the other type of investor, the corporate ones. These investors tend to work for a large corporation and invest the company’s money. Their goals are also to make a lot more money off of their investments but they are also tasked with producing a strange and esoteric thing called a “strategic return”.

In a nutshell, these investors have to invest to make money, and to make their company smarter by learning from you, the clever start-up.

For start-ups, having a corporate VC as an investor can have many benefits if the relationship is correctly managed including credibility, access to the corporations sales and engineering teams, access to go-to-market channels, and opportunities to conduct joint R&D.

So it is important that start-ups realize that pitching to strategic investors is not like pitching to financial investors. So here are a few ideas to get you started on your corporate VC pitch:

Prepare a pitch: Sounds obvious, right? You’d be amazed at how many start-ups show up without a pitch. I guess they think they can come in and talk shop for 30 or 45 min and that will be enough to land a deal. It isn’t. Show up prepared and ready to go.
Know the company’s investment thesis: Companies aren’t shy talking about their investments, so there should be a lot written about past deals. Don’t come in with a canned investor pitch, read up on past deals and come in with a pitch tailored to the company’s investment thesis.
Tell them why you’re relevant: Corporate VCs often have to get support from a BU for a deal, so help them position your company with the BU. Figure out which part of the company will be most interested in you and explain that in your pitch.
Better yet, have traction: Come in with a history of working successfully with a BU. Show how investing in you will help you scale/innovate and make the BU relationship even more successful
Don’t come in as a competitor: If you’ve built a competitive product that is better than theirs (or so you think), don’t think you’ll get money from them to keep you off the market. They won’t invest in you. They’ll probably just try to crush you. It is easier.
Come in as a partner: If you and the larger company are in the same space, it doesn’t mean they will necessarily be interested in you. “You do software, we do software” is not a compelling reason for a corporation to invest. Rather, tell them how your software (product, service) will help better position their software (product, service) in the market.
Finances: Oh yeah, nothing drives corporate investors battier than being treated as dumb money. You’ll need to come in and talk strategic alignment, but very soon the conversation will turn financial. Remember, these people live and breathe your markets every day, so they can tell if your market sizes/growth assumptions are for real

Meeting with corporate investors can be a maddening, time consuming process. They will ask a million question not only about your business, but on how your business relates to their business. So you need to know your business cold and their business cold. But if you come prepared with insight and some existing wins under your belt, this crazy process may have a profitable outcome.