This article was written by Matrix General Partner Josh Hannah.
More chatter today about valuations, burn rates, and everything that can go wrong. This advice to CEOs is from 18 months ago, but works as well today as it did then.
The alarm has sounded. A three-alarm fire, with alarms named Bill, Fred and Marc. Burn rates are too high, change course or risk the consequences.
A CEO might be forgiven for asking: “that advice might have been more helpful before I hired those extra hundred engineers, and leased the fancy SOMA exposed-brick office to house them in. Changing course on burn-rate now will be a lot harder than it would have been a year ago.”
To which I would say: suck it up and go run your business. The past is past, and the decision you need to be focused on as the CEO is: what should I do now? The board is not running your business, they merely advise you, and you are ultimately responsible for making the correct decisions.
The question remains: What should I do now?
If the market turns, many observers may criticize you for burning too much cash. “You idiot, how could you think it was a good idea to spend $3M a month?”
I am not one of them.
The best CEOs are great capital allocators. I’ve been meaning to write about this great book which delves into the key success attributes of great CEOs, but #1 on the list is they were great capital allocators. They chose the right projects to invest in, while managing the pace of investment and risk. They were aggressive at the right time, and kept their powder dry when it was warranted.
Most startup CEOs are not great capital allocators, and this trend has gotten worse as founders have become generally younger and less experienced. These younger founders have many great qualities, but they lack the time in seat to have good perspective around different types of markets. This makes the board’s role as a trusted advisor much more important on issues of capital allocation. My best CEOs are tremendous at this and owe a lot of their success to this single, rarely discussed skill. Many CEOs spend their resources using very simple heuristics: I have $10M and want it to last 18 months, so I should spend about $600k a month. This sometimes works, but these companies are at a disadvantage to their more strategic peers.
Three key attributes that separate an entrepreneur from an employee in my view are:
Capital allocation (human capital and financial capital) is a skill that will draw on your ability to make decisions under uncertainty.
When choosing how aggressively to spend money, you must look at the cost of capital. If capital is cheap, it would be wise to invest aggressively in your business. Recently, capital has been cheap for many companies, and for those companies, it was likely sensible to spend aggressively to grow, experiment, and cement a lead in a promising market.
However, as you decide how quickly to spend going forward, the important question is: what is the cost of capital likely to be in the future?
This is a difficult question. In stable times, it might generally make sense to just extrapolate from the historic cost of capital.
You will also be tempted to continue acting according to the board-approved plan for the year you agreed months ago. The wheels are in motion, the recruiters are out hiring, the lease is about to be signed. “We’ll revisit the plan when we make our new plan for the next year.”
A bad startup CEO is foolishly consistent in a dynamic environment. However, a CEO who changes the plan every three months based on the direction the wind is blowing is also a bad CEO. You can’t cut headcount by 30% tomorrow and just plan to rehire in a few months if this blows over.
What should you do?
Make the right decision. That’s your job. It’s not my role to tell you what decision to make. But it is your board’s job to advise you, and in that spirit, here is how I would think about the environment…
No one knows what the cost of capital (the price, and ease, with which you could raise more capital) will be in nine months when you will need to go out and raise. This is structurally unknowable. Even the venerable Sequoia Capital probably called it wrong with a “sky is falling” statement of RIP Good Times in 2008 — they were right about the macro issue, but not the duration, reportedly saying about the 12–18 month dip in Silicon Valley: “We are in the beginning of a long cycle. This could be a 15 year problem.”
Your job as a CEO is to make your best guess given the information available today. Try not to be too swayed by moments in time, as they may blow over. But don’t be afraid to make bold moves when you judge the situation warrants it, despite the hassle and work involved in doing so.
Bill Gurley just sounded the alarm in this Wall Street Journal interview about escalating burn rate risk. Fred Wilson followed on with a “What He Said” blog post agreeing with Bill. And now Marc Andreessen has gone on one of his trademark tweetstorms accurately laying out the negative consequences of getting out over your skis.
While these individuals do not know the future cost of capital, they do have dramatically more information about it than you do. Between them they have probably been involved in more than fifty late stage financings over the last nine months, and will have great perspective on the rate with which the behavior is changing amongst later stage checkwriters. No one has perfect information, but they probably have more than just about anyone else.
You can’t, however, always take investors’ public statements at face value. As Bill Gurley said, “every time a venture capitalist opens his mouth these days, he’s marketing himself.” You should ask: do they have any reason to falsely sound this alarm for their own benefit?
On balance, I would think the answer is no. With many, many companies in their portfolio that will need to raise more late stage funding over the next 12–18 months, it ought to on balance harm their financial interest to sound the alarm and cause the people writing late stage checks today to wonder if they are suckers to be doing so. In addition, all these guys have a history of being straight shooters.
So I think we can reasonably infer this new piece of information: the people with the most information and longitudinal experience about late stage financings believe the cost of capital has risen, or is going to rise in the near future.
Consider the asymmetric risk of overspending: on balance it is better to invest a bit too little and miss an additional opportunity than it is to overspend and run out of money, because you lose the optionality of something good happening tomorrow. Part of being a successful startup CEO is simply living long enough to succeed.
I don’t think it’s time to panic, especially if you don’t need to raise money in the next few months. But it is time to be at full readiness, with your strategic-thinking hat on. Ask yourself and discuss with your board:
If you’re a great entrepreneur, this is your time: a dynamic environment will reward your skill and steady hand. Do your job: Make good decisions under uncertainty.
Follow us on Twitter: Josh Hannah, @jdh and Matrix Partners, @Matrix Partners.