Igor Ryabenkiy: ‘Just break even’ is probably the worst possible advice for startups in these turbulent times

The economic turbulence of the last two years has forced startups to look for new survival strategies. Startups generally fall into two camps: a minority that can afford to continue doing business as usual because they have a strong market position and a powerful financial base, and the majority that is forced to adapt to ever-changing conditions. Among the latter, there are two types:

  1. Those that are faring badly (because they suffered a failed round or have bad unit economics or a resource-intensive business model that requires constant infusions of funds);
  2. Those that might soar, but could just as easily plummet (either because they are growing well but have limited runways, or else because they are flush with cash but have limited growth).

In these turbulent times, only a miracle could help the first type succeed. The second type, however, has every chance of not only surviving but thriving. This makes it critically important that they make the right strategic decisions now.

At this crucial juncture, the views of venture capital market leaders and respected mentors and experts carry added importance. And many have publicly and unequivocally given their advice to founders: lengthen your project’s runway and push it into the black. Many companies have enthusiastically embraced this idea, but the sad truth is that, in most cases, this is probably the worst possible advice for high-tech startups in a time of economic instability.

One of the most interesting companies in our portfolio almost fell victim to this advice. A mentor advised the founder to lengthen the runway as much as possible. We looked at how they would have accomplished this and discovered that the proposed cost-saving measures would have practically destroyed the company’s growth. At that point, the project would have held no interest to anyone. Why?

The answer is simple and stems from the nature of the venture capital market. In its early stages, a promising IT business might earn little but be valued at 10 times its annual profits. An investor buys the project for its prospective explosive growth, in the hope that he will earn many times more than his initial investment.

Now imagine what happens to a startup that chooses a belt-tightening strategy at the expense of growth. In practice, this means that the company had been spending heavily to maintain a high monthly growth rate of, say, 20% and that the venture capitalists who invested in it were eagerly rubbing their hands. Then the company decides to follow the advice of experts in order to become profitable at any cost. It slashes spending on growth and revenues fall proportionately. As a result, the company reaches the coveted break-even point at a much slower monthly growth rate of 5%. But even worse than the low growth rate is the much lower revenue the startup has accepted for the sake of hastening the day when it can earn more than it spends.

Whenever this scenario plays out, I ask myself one simple question: What will happen one year from now? How will investors respond after the company has applied this strategy for 12 months? The founder will point out that, despite the difficult times, the company is now profitable, has high margins and very steady growth. But the investors will see before them only a very ordinary business that does nothing more than stay afloat. Will this startup raise a new round of investment with so little systematic growth and even less ambition? No, it will not.

Founders tend to like the idea of hitting the break-even point as quickly as possible. Although their company might not become a unicorn, it can now earn them a stable salary and dividends. But for an investor, this is terrible. In this model, not only will the investor earn much less than he had hoped, but it will take years for him to recoup his investment. Unfortunately, the venture market is not about achieving slow, steady growth. And when a startup opts for profits at the expense of its ambitions, the whole point of its existence is lost.

Unfortunately, there is no universal method by which a startup can survive economic turbulence. The main thing is to not lose sight of your ambitions and the nature of the struggle in which you are engaged. Therefore, I advise the companies in our portfolio to:

  1. Conduct a review of their business and audit their finances and structure. There is always a smart way to trim a little fat. This is a natural process for startups: there are almost always more resources than needed and an audit can reduce them by 10%-30%, which can prove critical later.

2.Rethink business processes such as promotional methods or supply chain structure. Refusing to take the beaten path can radically improve the project’s unit economics and not only increase the time to the next round, but also make the project more attractive to investors.

3. Raise more funding. Although the result might be an annoying flat round or one that brings in even less than before, it isn’t tragic. Ultimately, it can buy the project time and resources that can help boost growth.

Published on TechCrunch+