How to run your startup in a recession
How to run your startup in a recession

As COVID-19 runs its course, it now appears certain that we will enter an economic recession.

For startups burning through cash, there are two forms of advice:

  1. Do whatever it takes to get to profitability
  2. Do whatever it takes to get to a certain amount of runway

For example, Steve Blank recommends doing whatever it takes to get to at least 24 months of runway. If you have less than 24 months of runway, please stop reading this and read Steve’s article — every day counts! But if you already have 24 months of runway, what do you do?

Let’s consider both options.

Get to profitability

Getting to profitability will feel good and will also give you leverage. You will never need to raise funding unless you want to, and this ability to walk away is key to raising on great terms.

However, getting to profitability will probably mean that you have to hire and build slowly.

If you raised money from venture investors, then you are likely in a big market that can support a massive outcome. While you focus on profitability, it is almost certain that a venture backed competitor will invest more aggressively. If they are competent, they will generate compounding momentum such as brand recognition and network effects. And if this competitor survives the recession, they will end up significantly further ahead.

Get to a certain amount of runway

Let’s assume you do whatever it takes to get to 24 months of runway.

Are we out of the woods? Not quite yet.

What if you miscalculated, and it later turns out that you only had 18 months of runway? Or what if 24 months passes, and it later turns out that the market for capital is even worse?

These are not far-fetched scenarios. No team executes perfectly, and we may be entering a recession that could last many years. From my perspective as an angel investor, I have seen early stage valuations drop 20-30%, and I have seen term sheets pulled.

How long will a recession last? Historically, the longer it takes for a crash to reach the bottom, the longer it takes to recover. And on average, it takes roughly 3 times as long to recover from the bottom than it takes to reach the bottom from the peak.

We have seen the markets recover in response to the stimulus package and the more recent news of the virus slowing down. I would love to believe that this mark the end of any crash, but the path from peak to bottom is often interrupted by false rallies.

At Superhuman, we are planning for a recession to last 2-4 years.

Which strategy is optimal?

You could do whatever it takes to get to profitability. Or, you could do whatever it takes to get to a certain amount of runway. In practice, neither strategy is optimal.

For many startups, I think that this is the optimal strategy:

  1. Choose how much runway you want to maintain (e.g. 24, 36, 48 months).
  2. Every year, adjust your net burn such that your runway is always at this level.
  3. You can reduce net burn through revenue growth and cost reduction; conversely, you can increase net burn through faster hiring and more marketing.

This strategy seems deceptively simple. But it provides a clear algorithm — that everybody on your team will understand — for balancing the need to grow against the headwinds of a recession. It also guarantees positive outcomes in a wide variety of scenarios:

  1. In the scenario where the capital markets do not recover, you will not have to fold or take a down round.
  2. In the scenario where you execute imperfectly, you will not have to fold or take a down round.
  3. In the scenario where revenue growth resumes, you will reinvest as much as possible in your team and roadmap.

How much runway should you maintain?

If you do not have much cash and are not making much revenue, you may have to choose a 24 month plan. If you recently raised or are making lots of revenue, you may be able to choose a 48 month plan.

But be aware of this critical tradeoff: the shorter the runway, the harder it is to maintain that runway. If you choose 24 months, you have to reduce net burn by 50% every single year in order to maintain 24 months of runway. But if you choose 48 months, you only have to reduce net burn by 25% every single year in order to maintain 48 months of runway.

For example, imagine you have $10M in the bank. This is the 24 month plan:

Constantly maintaining 24 months of runway

Notice how you never actually run out of money, as you always have 24 months of runway.

In 2020, you can grow net burn to $417k per month. But in 2021, you have to reduce net burn by $208k per month. This is equivalent to increasing your annual run rate by $2.5M. If you are not sure that you can do this, this plan becomes very risky.

With the same capitalization, this is the 48 month plan:

Constantly maintaining 48 months of runway

In 2020, you can grow net burn to $208k per month. This means that you only hire half as many people in this plan. But in 2021, you need only reduce net burn by $52k per month. This is four times more feasible than the 24 month plan!

This tradeoff is why many companies are topping up their last rounds — it will let them execute the 48 month plan with a reasonably sized team. If the business performs then they can invest in growth, but if the business does not perform then runway can be maintained with only moderate corrections.

How frequently should you adjust net burn?

To keep these examples simple, they adjust net burn once a year. But the markets are changing rapidly; if you adopt this strategy now, you will probably want to adjust it more frequently.

At Superhuman, we plan to adjust net burn every quarter.

Have you adjusted your revenue forecast?

You can reduce net burn through revenue growth and cost reduction. You can increase net burn through faster hiring and more marketing. But which of these four levers do you actually control?

You fully control three of them: costs, hiring, and marketing. But right now, for most companies, revenue is hard to control.

If you have not yet adjusted your revenue forecast, please consider doing so before using this strategy. Many startups are seeing churn, contraction, and all kinds of new problems. Most startups that I know are planning for revenue growth to be less than half of previous estimates. And although this is hard to predict, you can use the product/market fit score to help.

Ask your users “how would you feel if you could no longer use the product?” and measure the percent who answer “very disappointed.”

You might assume that you lose most users who answer “somewhat disappointed” or “not disappointed”. You might assume that you retain most users who answer “very disappointed”. Even for companies with strong product/market fit, this would lead to a revenue headwind of 50% or more.

Try it yourself

If you would like to try this strategy yourself, just checkout this spreadsheet:

The fine folks at Coda also created this interactive calculator.

All you will need is your current cash balance and the amount of runway that you would like to maintain!

Closing thoughts

We are all still concerned for the health of our loved ones, and many of us are figuring out a new way of living. The last thing any of us want is a recession that will impact friends and family.

I would love to be wrong, but a recession seems inevitable. Companies that have raised money need to figure out how they can not only survive, but thrive. For most companies, getting to profitability will stifle long term momentum. But for most companies, picking a fixed amount of runway will be a bridge to nowhere if this recession is bad.

I think that the optimal strategy is to choose the amount of runway to maintain, and then adjust net burn regularly in order to maintain this runway. This is very easy to understand, and leads to success in a wide variety of scenarios. If competing companies all run this strategy, the winner will be the one that executes best — which is exactly as it should be!