Is Silicon Valley in a bubble? By looking at the various articles from VCs, it would appear that not only are we in a bubble but that bubble is slowly leaking and may be close to bursting. Many VCs who went through the dot.com bust are expressing their opinions, and after reading a column in Business Insider by Heidi Roizen, a partner at Draper Fisher Jurvetson, on an investor perspective of the dot.com bust, and a letter sent by First Round Capital to its limited partners, I thought it would be a good idea to see the same story from a founder perspective and see what lessons may apply to today’s entrepreneurs as the funding market slows down.
It was the end of October 2001 and our “hot startup” IpVerse, ran out of money. Many companies closed and failed to raise any money but we survived and thrived and ultimately went public in 2007 as Veraz Networks after a long journey. Here are some of the lessons that may apply to entrepreneurs as they deal with a tightening funding market.
Do investors really get an early warning?
Vinod Khosla, who was with VC firm Kleiner Perkins Caufield & Byers at that time, was on our board and we used to go and meet him from time to time for an informal meeting. We met him in April 2001 and he told us that the telecom industry was overinvested and capital would soon dry up.
There were just too many telecom software startups like us that depended on many startup telecom operators who in turn depended on investment and equipment financing from bigger telecom companies like Cisco, Nortel and Lucent. His advice to us was to reduce burn significantly and do it now. By the way, Nortel went bankrupt and Lucent merged with Alcatel to survive the downturn.
Our executive team decided to sell the rest of the board against that idea and we succeeded in getting the board to agree that a slowdown was coming but a doom scenario was too far-fetched. So a smaller cut was put in place. Then came the disaster of the attack on New York’s twin towers and all the predictions of doom came true. Had there been no such disaster, would we have really seen such a bad market? Did Sequoia’s famous RIP presentation of 2008 result in investment squeeze or was it really that bad in 2008?
Heidi’s article is not the first one but definitely will contribute to scaring more investors and thus ultimately create the capital squeeze everyone has started talking about. Therefore, as an entrepreneur, I do believe that if your business depends on external financing, listen to the early warning signs and make adjustments to your burn. Do it sooner rather than later.
How much of burn should you reduce?
Khosla recommended that we do a drastic cut in the burn rate of over 50%. It still would not have made us cashflow breakeven but would have given us six-months or more of additional time to raise the next round. The rest of our board disagreed and we decided to do a smaller 20% cut.
At that stage, we felt no need to change the product mix or release schedules as a 20% cut would create enough efficiency to offset any loss of productivity from laid-off employees. Being an entrepreneur, I would say that most companies with more than 100 employees can get rid of 20% of staff without a significant loss of productivity.
Then came the terror attacksd, and raising money became a herculean task. We managed to raise the next round but had to let go of two-thirds of our staff; a decision that is probably as much if not more painful for founders and executives who had to make the decision of who to let go. How did we manage to cut staffing and reduce burn so drastically within six months? The remaining executive team decided to keep only one product line where we had a chance to become a top-three player in the market and put all other initiatives on hold for better times.
My recommendation to fellow entrepreneurs is to reduce your burn by more than you can live with and do it earlier rather than later. It only gets more painful and you lose employees you want to keep. After this drastic reduction we had practically zero attrition for the next few years until we grew to 450 people when we went public.
Which investor can you count on?
It is true that when things go wrong the chances of raising money from the outside are going to be small and your survival depends on which of your existing investors are going to step up and support you. Do not expect all your existing investors to do so, and certainly not at the last valuation. We were lucky to have the support of Promod Haque of Norwest Venture Partners, who stood by us and convinced all other investors to support the company.
For founders who have already raised money it is time to take stock of your investors to establish who will and who will not stand with you when you run out of money. Founders in the process of raising money should also ask potential investors for an example of how they supported their companies in the previous financial crisis.
Motivating employees is more important in difficult times
Keeping morale high is more important in tougher times, as you are now dependent on fewer employees to do more. Usually, companies tend to take smaller things away, like free drinks or food that only makes morale worse while having no significant effect on the bottom line. Instead of making smaller cuts at regular intervals, make one large cut and reduce more staff than needed.
After the cuts are done, make every effort to keep your existing employees happy by being transparent and creating an open communication environment wherein all employees have, and feel they have, a stake in the success of the company just as it used to be when you started the company.
Customers get irrational in recession
Let us hope recession is not on the cards any time soon. Unfortunately, 2001 was the worst time for the tech industry I have ever seen, and we learnt many lessons that may be useful if the economy does slow down. Contrary to common belief, customers – especially larger companies – do not necessarily want to buy the newest, most efficient system from a startup, but instead go back to buying from their safe incumbent vendors.
We looked to upcoming telecoms countries, including India, China and Russia, to find new customers. We merged with a division of ECI Telecom that gave us access to many of these markets. Rather than building business on the strength of a few large customers, we built the business with many smaller customers and survived.
Conclusion
Surviving financial downturn is hard for any company, especially startups that have to raise money constantly. Not every company can become cashflow breakeven overnight, but at times like this one should tighten the belt and focus on fewer things where your company can be a leader rather than disperse energy in multiple initiatives.
Know the investors you can count on and what it would take to have them support your company in tough times. No matter what, it is a good team that pulls a company through any crisis, so never lose sight of keeping your team motivated at all times if you want to win.