How to Survive the VC Deep Freeze

As a new CEO of an early-stage startup, I feel like I was sold a bill of goods.

When I first considered joining a startup in the middle of 2021, stock prices were at all-time highs. Venture capital markets had reached a frothy crescendo where pre-revenue companies routinely raised millions of dollars in Series A funding. Later-stage companies received astronomical Series B and C rounds. Entrepreneurs assured me that (1) we could easily raise large sums of money whenever needed and (2) we should grow from 0 to 100 as quickly as possible.

I decided to pursue the dream of joining a startup and gave notice to the exceptional company where I had spent my entire career. Then the world changed. The once-hot VC market showed signs of cooling, Russia had just invaded Ukraine, and the economy was showing signs of inflation.

“No worries,” I thought. “It isn’t fun if it isn’t challenging.”

And so, undaunted, I joined three other founders on the journey to entrepreneurial success. Fast forward a few months, and we find ourselves in a veritable venture capital crisis: VCs essentially stopped investing, the war in Ukraine rages on, startups worldwide are laying off employees, and we’re entering a period of sustained high inflation.

So how is an early-stage startup supposed to manage in these difficult times? I couldn’t find much information on the web, so I contacted my network of current and former CFOs and CEOs for their perspectives. Most of them represent large organizations, so we had to map their strategies and experiences to the startup context.

Primum is a three-sided knowledge network consisting of demand-side general oncologists with challenging clinical cases, supply-side disease specialists with deep expertise in their niche, and corporations that pay to access peer-to-peer insights. Our original plan focused on rapidly growing our panel of experts to drive the adoption by community oncologists, followed by optimizing oncologist engagement. With high adoption and user engagement, we believed we could raise a Series A in early 2023, using the proceeds to build out our network’s third and revenue-generating side.

Needless to say, we have had to adapt our approach to the current environment.

One of our advisors wisely asserted that the most critical responsibility of a startup CEO is not to run out of money. With the probability of raising funds in early 2023 rapidly approaching zero and the prospect we’d entered a period reminiscent of the multi-year 2000 dot-com bubble burst, we rethought our tactics. We switched from an operating plan designed for high growth to one optimized for cash preservation to extend our runway. Even if we followed the original plan and met our growth targets, raising a Series A in this environment would be like hosting a debutante ball in the middle of a pandemic–no one would come to the party!

Here’s what we decided to do:

1. Postpone our Series A “debut” until we can maximize attendance — sometime in the spring of 2024.
2. Create a new plan for 24 months of runway, assuming no new sources of revenue.
3. Establish a hurdle rate to ensure we invest intelligently.
4. Continuously revise that plan until our revenue exceeds our operating expenses, and we become “Default Alive.”

Since we are pre-revenue, our baseline 24-month plan assumes no revenue, new loans, or fundraises. To provide a buffer for unplanned emergencies, we set our monthly burn-rate budget by dividing our current committed funds by 30 months’ runway. Thankfully, this burn-rate budget is enough to sustain our current activity level with a little extra for experimentation and investment in marketing.

Most startups don’t suffer from a lack of opportunity but from a lack of prioritization and sequencing; therefore, we agreed to prioritize and sequence new activities as a team to have complete visibility of our business needs and allocation of funds. We adopted lightweight governance to ensure we never exceed our monthly burn rate. Our leadership team reviews our KPIs and finances weekly so that we can adjust our spending and activities accordingly.

In addition, we developed our own hurdle rate for new investment opportunities based on a model of our future valuation using ‘conservative’ 2017 valuation multiples (future valuation = projected trailing twelve months’ revenue x growth multiplier). The hurdle rate reflects the extra revenue and growth rate an investment needs to offset the impact of shortening our planned runway (roughly the loss of future income) on our future valuation. While we thought this was pretty clever, a CFO advisor thought this was similar to computing our cost of capital—textbook CFO stuff.

With our baseline plan set, we decided in advance how future revenues would affect our operating budget. We felt the most straightforward approach was to add new revenue to our cash reserves. Then we recompute our monthly burn-rate budget (cash reserves/months remaining), which effectively amortizes the new revenue over our remaining runway. Recall that we only invest in activities that exceed our hurdle rate (capped by our burn rate budget), so most of the time, new revenue simply extends our runway.

Our “Default-Alive” plan will search for ways to generate revenue sooner and produce enough free cash flow to cover our operating expenses without compromising our strategic vision.

Many lessons from the C-suite of a large corporation translate to the realities of a startup environment. Managing a startup differs considerably from managing a multi-billion dollar corporation; however, most good business practices span the spectrum. Sound fiscal management will ensure we remain viable if the current crisis lasts 24 months. If the economy improves, we will transition back to our original plan, much stronger than before.

Corey Zankowski is the founder and CEO of Primum, a startup dedicated to bringing expert knowledge into the community so that more patients can receive excellent treatment closer to home. This post originally appeared on his Medium page.