Cash-flow breakeven: Controlling your own destiny?

There’s a phrase I’m hearing in startup-land that I haven’t heard for a long time: “control your own destiny.” It means get your startup to cash-flow breakeven (CF BE), and then you’ll have lots of choices.

The last time this was common speak was during the ‘08-09 crisis. With a recent flight to quality in Seed funding and a crunch in Series B funding, the pursuit of cash-flow breakeven is a very worthwhile consideration now, though not a panacea. In general, the funding environment you launch a startup into – and the cash burning or saving culture it breeds – changes a startup’s path indelibly. Depression babies behave very differently than Boomer babies!

Using YC cohort and Pitchbook funding data, you can see below what happened in the last cycle. When the ‘05 to ‘07 Seed and Series A growth trend reversed in ‘08, the 2008 YC Cohort had more limited access to capital, and their failure rate doubled. After that experience, it seems YC leaders wisely coached companies in ’09 and ’10 to be more cash efficient and assume the worse for funding, at least early on. The result? The failure rate approximately halved in ’09 despite continued difficult funding dynamics.

VC.pngSource: Pitchbook, Seed-DB YC page

Wow. What a difference a year can have on one’s perspective. I’d love to hear YC’s take on how the funding environment changed their coaching then and now…

So does this mean every startup should try to get to CF BE as quickly as they can? The above case study supports that it’s a good idea if your goal is not shutting down (avoiding dead). But for many startups and pretty much every YC company I know, that is not the goal. The goal is to build a big, or a at least meaningful, company. Then the decision to drive to CF BE is more nuanced, even in today’s funding environment. Getting to cash-flow breakeven is a terrific idea when:

The target market is small, or the product is really a “feature”. In this case, proving the economic model through overall profitability, avoiding raising much capital and chugging along with 25-75% growth a year can be very value optimizing for founders who are pursuing a $25 to $75M exit.

Capital is or is expected to really dry up. Okay, this is the premise of this article and kind of an obvious. However, all funding isn’t disappearing right now. Rather, there is nuance by stage. Series B is getting harder to get, so middle-of-the-pack Series A startups might be wise to reach profitability. The same is true for very late stage startups who won’t have access to as many monster rounds in the new funding paradigm. Late stage profitability seems pretty smart right now.

When you are very early OR very late to a market. AI, IoT and vertical SaaS are raising lots of money now, because those markets are hot (at least in investors’ minds). Five years ago that wasn’t the case. On-demand marketplaces, social and horizontal SaaS were the rage. At that time, AI and IoT companies should have been hunkering down near profitability to buy time. Now in turn, it’s time for all but the best and fastest growing on-demand marketplaces, social applications and horizontal SaaS startups to consider CF BE. The best of these companies, however, can still raise tons of capital as they emerge as category leaders in these more developed markets.

While cash-flow breakeven always expands and extends options – you can keep growing organically, raise capital later to spike growth, get acquired with a smaller capital stack – there are risks too that every startup team should consider:

When scale or speed matter, slowing down to get to CF BE can undermine ultimate success. While all tech companies have returns to scale because software code has zero marginal cost, startups and products with real network effects (marketplaces, some consumer SaaS, social, etc..) can find huge enterprise value benefits to getting bigger faster with capital. Further, many markets with network effects are winner-take-all, so hunkering down takes you out of contention to win.

The slow growth spiral is also a big risk of CF BE. Startups often target CF BE because they can’t raise capital. They often can’t raise capital because they aren’t growing fast enough. Then, once they get to CF BE, they are likely to be growing even more slowly, further reducing their ability to raise capital. Vicious cycle. The best bootstrapping companies we see in the $0.5-2M revenue range are growing at 50-75% per year. This is an incredible accomplishment without outside capital, but we are typically looking to invest in companies growing >200% YoY at this stage. This suggests that getting to CF BE may, in-fact, preclude the option to raise capital later.

How do you later find your way out of CF BE if you decide to go there now? Walk before you run. I’ve met with a few amazing companies recently that are doing just this. They have a $1-2M in revenue and are growing at 50-75%. They can’t raise the normal $5-8M venture round at this stage because they don’t have the growth rate to give VCs confidence of hyper-growth. So they are starting small by raising a $1-2M angel round – there is a segment of angels that love CF BE businesses growing at 50-75%. These startups will use the cash to prove they can burn effectively to achieve high growth, bump growth to 200%+ for a year and then have the metrics to raise VC capital if they want. There are also private equity, growth capital and strategic investors who might prefer a company with more moderate growth and less burn. Venture is not the only model for capital.

10 thoughts on “Cash-flow breakeven: Controlling your own destiny?

  1. A criteria I used at Zipnosis as we sailed past BE was the relative Enterprise Value increase through operations (organic sales growth) vs. financing (venture, debt/etc.). By exploring the valuations vs. my time to recognize revenue in a profitable manner, it was clear that I was going to dramatically increase EV through financing faster than I could ever do it organically. It bolts on to your comment on not enough growth so you can’t finance so you can’t grow faster. As a CEO, I’m always focused on Enterprise Value growth and using my levers to drive that. Break-even and FCF are awesome – but to your excellent points, can’t be valued in a vacuum. If the financial markets will reward you with 10x return on revenue (or some compelling multiple) and you can only grow top line by 2x, it makes more sense to eschew BE and grow using outside capital.

    Thanks again for the thoughtful post. So many aspects to this – it’s hard to distill down and bottle.

    Cheers,
    Jon

    1. Jon, terrific insight on EV creation…. and worth pointing out that your timing of switching from CF BE to CF burn seemed well timed to when the market was ready!

  2. Great article and I think the points are totally valid and on-point. One small note: One of the reasons for so many failures in the 2008 batch for YC is that they let in a substantial amount of founders with no idea on what product they were going to build (the so-called “no ideas” batch). I think that’s part of what led to the high failure rate.

  3. The curves cross between CFBE and Bootstrap. A Bootstrapped business at $10M in ARR where the founder owns close to 100% produces the same exit for a founder as a company at $100M ARR who has taken in capital and the founder is diluted to 10% ownership. $10M ARR at a 5X valuation equals $50M exit for founder. $100M at a 5X valuation is $500M x 10% = $50M Exit. Of course I played with the valuation multiple and of course growth rate affects valuation multiple. But there is much more risk raising money. Especially with liquidation preferences, ratchets and the other terms which ultimately impact the exit for a founder.

    1. Agreed, and I like the “have to believe” comparison. By definition, preferred equity makes common equity more risky. In general, taking cash more likely to be optimal when speed and scale especially matter.

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