Venture capitalists are driven by emotion. They swing between Fear of Missing Out (FOMO) and what I called Fear of Losing Everything (FOLE). I think the FOMO peaked out in August when WeWork was thinking it would be able to go public at a valuation well above its January 2019 valuation of $47 billion.
But WeWork pulled its IPO and a big investor, SoftBank, decided to pour billions more into the company at a $7.5 billion valuation -- 84 percent below where it invested at the beginning of the year. Meanwhile, ride sharing giants Uber and Lyft are trading well below their IPO prices.
This is bad news for venture capitalists and their institutional investors and now some founders are acting as though the VC community will be in FOLE mode soon -- if they are not there already. When VCs feel this way, they tell their portfolio companies to lengthen their runways, meaning they should make the money they've raised last longer by cutting unnecessary costs,
Here are some examples of such runway lengthening founders. According to the New York Times, Mark Frank, CEO of Denver health technology provider, SonderMind, abruptly altered his capital plan. Instead of spending all of the $3 million in capital he raised in April 2019 and going out to raise another round at the end of 2020, he decided to cut spending and try to raise more capital in early 2020.
Frank is not a fluke. The Times interviewed Scott Orn, chief operating officer at Kruze Consulting, a San Francisco firm that does accounting for over 200 startups. Orn said that in the first quarter of 2019, his clients had an average cash balance of $3.5 million and were burning $260,000 a month. By the third quarter, their cash balance had increase by $1 million and their monthly burn rate had dropped by $30,000.
I am guessing that many of these companies are responding to changes in investor mindsets. Ben Parr, president and co-founder of San Francisco-based customer service software provider, Octane AI, said that in 2018 investors asked him about his month-to-month growth rate. Now they want to know how long it will take the company to break even, according to the Times.
Building a Scalable Business Model
It's time for your business to follow the lead of these founders. The question is: what should you do?
As I have written several times this year, many companies have been skipping the second stage of scaling, building a scalable business model. Instead they've gone from the first stage, winning the first customers, to the third one, sprinting to liquidity.
If you are guilty of this charge, you now must go back to stage two and make your business model scalable. That means, you must make your key business processes much more efficient. For example, cut the time and cost to persuade new customers to buy your product.
One way to do that is to market to people who need your product the most, let them try a simple version of the product for free, and when they want to buy a fully-featured version, have them call in to a so-called inside sales department to find out how to configure it for their company and start paying you.
A scalable business model also means making your company more valuable to your existing customers by adding new products and features that they need. As I wrote in April, this is a skill at which Zoom Video Communications excels.
A scalable business model should be cash flow positive and likely to remain so when your company takes on new capital to expand into new geographies and enter the third stage of scaling.
Another thing you can do to preserve the cash you have is to cut what I call non-value-added costs, costs that do not contribute to making your customer experience tops in your industry.
Amazon used to excel at this-- giving new employees door desks in spartan spaces with threadbare carpeting-- and otherwise not splurging on expensive outings that involve first class travel, four star hotels, and champagne and caviar meals.
In that spirit, cut back on marketing budgets you may have ramped up to spike monthly revenue growth. Move to less costly office space and otherwise lower your fixed costs without diminishing the customer experience.
Times have changed and you won't survive the coming venture capital drought unless you make your business cash flow positive. These tactics will help you get there.