Hi {{First Name|friend}}

I studied the last 3 tech bubble crashes and found the 2 biggest killers of startups.

The 1st reason is that they waited too long to cut costs.

Seems like a no-brainer but better Jedis than us have been misled in this turbulent time.

From Evan Williams (before Twitter) to Marc Andreessen (before a16z), many great entrepreneurs of successful companies ran out of money or came close to it in the aftermath of a bubble.

If OpenAI turns out to be the next Lehman Brothers & the AI heavens split open,

here’s a very likely scenario of how we could go broke in 18 months… even with a strong piggy bank.

A slightly profitable bootstrapped startup invests in a growth plan as the Nasdaq starts falling.

Let’s say we’re a slightly profitable 25-person $4.2M ARR startup with

Well then our net cash flow goes from positive to negative over the next few months, but we don’t mind coz it’s investing in the business.

But then a few new accounts fail to materialize & slip to next quarter. We chalk it up to the crazy times we’re in and keep moving.

6 months in, our ARR is still flat but now our runway suddenly went from profitable to 20 months.

We’re not worried, that’s more than enough time to turn things around. Also everyone’s stalling in this economy, we just got to stay the course & we’ll get back on track.

But then something happens that we weren’t expecting.

A handful of weaker customers leave at time of renewal, all at once.

They had annual contracts so we didn’t notice the churn earlier in the year, and because it happened around budget review season, it feels big and sudden.

Now we’re panicking and decide to ramp up efforts to win them back, by giving out discounts and adding engineers to build new niche features to get them back.

This is where we fall into the greatest trap.

That extra $20k a month doesn’t seem world changing and in ordinary times, this would be a smart investment to save our existing revenue. But these aren’t ordinary times and that critical move kills the math.

Because here’s what we miss: Most of the damage hides on the revenue line as we’re obsessing over the additional costs.

It reduces our runway from close to 2 years to 5 months. 🫪

Even though our Saving Private Ryan efforts save a few flighty chickens, more start taking off. And since we still need to maintain these new promised features, all in all, our costs stay up there.

And every time we push up the ARR, it slides right back down.

The worst part: We’re so deep in fighting to gain back lost ground, that we don’t see our real cash position.

Until someone forces us to and that’s when we feel a terrible shiver go down our spine.

By month 9, we’re down to 2 months of cash.

We realize we’ve deeply miscalculated and start course-correcting drastically.

We cut the win-back spending, lay off 7 people and stop paying ourselves. Most likely we lay off a few Customer Success reps coz they’re the lowest hanging fruit we can cut. This new customer-to-CS ratio is much more shakier but still manageable.

The team is visibly jarred by these traumatic cuts but we tell them that this is the only cut we’ll need to make.

They’re shaken but they believe us. The whole ordeal has aged us a few years.

But we’re in the green, so we’re safe.

All is quiet on the western front for the next few months.

No one is taking risks and we have stopped shipping anything meaningful. But at least the churn has slowed and we can see a path out. Heck, we even start paying ourselves a little.

We have no idea the worst is yet to come.

Like any good recession, it comes in waves. Here’s the second one and it’s seismic.

As the financial rot spreads in the economy, we start seeing wonky behavior all over.

By month 14, one-fifth of our customers start paying 30 days late or pausing their accounts so that now creates a one-time $50k cash hit. It also doesn't help that we gutted the CS team, so they can’t keep up.

We have officially slid into the crimson but we don’t lose hope.

We tell our team not to panic, We didn’t lose that revenue, it’s just late. Pauses are not cancellations. That money will come through.

We glance at the P&L to confirm this & breathe a sigh of relief seeing that it’s only a $10k loss.

A 13 month runway doesn’t seem too bad seeing as we were at 2 months not too long back.

But the hits keep on coming, without malice or mercy.

Cancellations and downgrades roar through the countryside. Also our competitors, the ones with deep pockets —they keep shipping this whole time. These uninspiring copycats are now winning our deals.

The runway has now fallen to 5.5 months.

We’re now dying on the inside. There’s no way we can cut people a few months after the last one.

Plus that first round of layoffs was a little easier because those were new hires to help with the growth. Everyone that’s left on the team now is critical to the cause.

And if we cut this part of the body, it’ll kill the culture.

So we create a termination-to-solvency plan… but we just sit on it.

That’s when we get hit with the yearly insurance and software bills, something we completely forgot about.

And we’re back in the hole we clawed to get out of.

So we do the unthinkable and cut off another arm.

We feel absolutely wretched for breaking our promise to our team and we try to comfort ourselves saying it was necessary. It was.

But here’s the cruelest irony, all this bloodshed second time around, only gave us enough cash to pay a week’s worth of bills.

Congratulations, we’ve barely survived our 18 months.

But have we?

Here’s how it plays out in a funded startup, but with far more dire consequences.

Whereas bootstrapped startups may barely survive this economic downturn, funded ones often don’t make it out of that 2nd wave.

It’s because they’re in what Paul Graham calls the fatal pinch.

Fatal pinch = default-dead cash trajectory + slow growth + not enough time to fix it

None of these decisions were stupid.

Each one made sense with what the founder could see in that month. But here’s 3 reasons why founders don’t make those hard choices earlier:

1. We don’t know the real number

It’s primarily because the P&L and the bank account disagree. Maybe we don’t have solid financial reporting or maybe we’re too hyper focused on monthly ARR movement. Either way, we’re not realizing the true cost multiples of the choices we’re making.

2. We are so close, if only we can hang on longer

Economies change faster than our perceptions.

Everyone is in a slight state of delusion. The bountiful sales record of the past few quarters and the great beautiful product roadmap ahead of us leads us to believe growth is right around the corner. We dismiss the red flags on the path up to Everest, including our fast depleting oxygen supply for the climb down.

This is also why if we’re bootstrapped owners, we throw our own money here to cover the gap. Disavowing a paycheck for a long time and paying off debts ourselves allows us to extend the belief that we can make it if we just survive this.

3. We believe we’re owed this success

The ultimate psychological root of why founders don’t make hard decisions faster is entitlement. We believe we deserve this success because of how much we’ve sacrificed and faced to get here. We have done everything right and we’re owed this.

Because the alternative is unbearable.

If we make those cuts, we’re saying our whole thesis is wrong. All that we convinced these really smart people to follow us on and stake their whole livelihoods on —it’s a false premise. It means that these past few years of soul-crushing effort & sacrifices was for nothing.

That we cannot abide. We will never let that happen.

That’s why we hire people and increase marketing spend on term sheets & handshakes. That’s why we spend cash we don’t have in our hands.

Because the act of spending that money, negates the reality that you have none.

Coz if I just spent it, that must mean I have it.

Even if we do survive all those layoffs, our darling business is a shell of its former self and spiraling down.

Low cash doesn't kill a company on its own.

It takes away the good options, guts our team, makes the remaining cuts more painful and starts scaring away our customers.

By the end, we’ll be operating like the walking dead and wishing for the pain to stop.

Paul Graham says founders giving up is the most common way startups die.

Now we know why.