Early stage CEOs: time to pull back or push ahead?

By: Pat LaPointe, Frontier Angels

After my last post, quite a few people asked if I was suggesting that ALL early stage companies should be pulling back in this uncertain time. 

No. Just ~90% of them.

The problem is that 90% of entrepreneurs think they’re in the other 10% who should push aggressively forward. Here's some thoughts to help you determine which strategy may be right for you.

First, some context… the biggest challenge to early stage companies dependent upon equity capital for survival is the enormous shift occurring in the dynamics of capital availability:

  • Due to simultaneous crashes of the stock market and the oil sector, most individual investors are scaling back their early stage investments to preserve cash until they have a clearer sense of the mid-to-long-term risks. There is less money in the angel capital world today than there was a month ago. Chances are there will be even less in a month.
  • Venture funds that are in the later stages of their deployment phase will be concentrating even more on companies who can exit fast since their horizon for returns is more limited. And they’ll be much more sensitized to each company’s potential need for more capital to get to exit, wondering if that capital will be available when needed.
  • Venture funds that are early in their deployment will more likely take a wait-and-see approach and only do deals where they can find really attractive valuations right in the sweet spot of their focus area.

On the whole, this will significantly disrupt the supply/demand relationship for capital for more than a few months. The people with capital will be a lot choosier in where and when they invest it. Fewer deals will get done at lower valuations and they’ll take longer to close. It’s sort of like playing musical chairs only the music is faint, you can’t tell how many chairs there actually are, and the number of contestants gets bigger each round, not smaller.

For the early stage CEO this means don’t run out of capital before your story is so compelling that you can ask for more and realistically expect to get it. In fact, you better reach that point at least 6 months before you run out of capital because you definitely do not want to have to negotiate for more capital when the investors know you’ll bottom out in a few months and will get increasingly desperate if they drag their feet.

Against that backdrop, take a look at how much capital you have in your bank account. Subtract the bills that you must pay in the next 30 days, and then divide by your monthly cash burn rate. That will give you your estimated runway time to zero, measured in months.

The next important thing is to know the true value inflection points on your growth curve. What milestones will make your company materially less risky and more attractive to investors? Is it achieving the first 100 customers? 1000? Or is it getting the right results in your phase 1 pilot or clinical trial? Or is it $30k MRR? If you don’t have a good handle on this, ask some professional investors. You’ll likely get lots of different answers, but in gathering them you’ll better understand how the investor community is measuring risk/return in the current market environment. Yes, it’s frustrating I know, but we DO actually change both the goal-line and the yardsticks every so often as we adapt our portfolio strategies to more macro forces.

Now that you know what your milestone targets are, the question becomes can you hit them with the cash on hand and still have some reserves in the tank? This is the 90/10 question.

If you are doubtful that you can hit the milestones with current capital on hand, you’re in the 90%. You should hunker down and figure out how to survive longer on the cash you have available. Think about making some progress towards your milestones, but also about living long enough to see the proverbial sun come out again and see the capital markets flowing. More specifically, see my earlier post. Who knows, something may change the calculus and a door may somehow open while you’re waiting patiently and watching.

If you have a clear plan and strong evidence suggesting you can get to the key milestones and still have some cash left over, you may be in the 10%. Maybe you should go for it. But know that in choosing this path you are deciding to bet the company, and make damn sure you are not just drinking your own KoolAid, mistaking hope for judgment. Put your plan in writing. Identify the leading indicator metrics that will tell you if you're on the right path soonest. Get some outside expert advice on your plan. Identify the key risk factors. Review your mitigation strategies and contingencies with the most skeptical, pessimistic SOB you know. And be careful not to take on fights with forces far greater than you.

The world has far more case studies of companies who failed thinking they were in the 10% than of companies who chose the 90% path and regretted it later.

Only YOU know if you should ride out the storm or press ahead. Beyond all the planning and analysis, there's an "X" factor that no one can really explain. There’s no shame in deciding to ride it out, and no glory in watching your bank balance go to zero. It’s true that great companies are sometimes born in times of major disruption. But it’s more true that great companies are forged by weathering challenging times and emerging ready to pounce when the wind shifts to their back.

Good luck on whatever path you choose, and know that the investor community is rooting for you to succeed, either way.