“Leading Your Midstage Startup Through the New Normal”

Show Notes

All startup leaders are currently facing the challenge of leading their company through the new normal of low startup valuations. Valuations started to drop during the second quarter of 2022 and it could take time for the economy to rebound. In the meantime, what are startups supposed to do to make sure they are able to survive these dark days and still put themselves in a position to thrive?

Startup coach Roland Siebelink provides answers to those questions during a 25-minute webinar on getting through the new normal and the best ways for startup founders to lead during this time. The webinar covers five topics that are on the minds of every startup leader, or at least should be on the mind of every startup leader.

• What exactly is this new normal?
• How long will this new normal last?
• How can startup leaders maintain their credibility during this period?
• How can startups ensure their survival by focusing on their core?
• How can a startup extend its runway by making hard decisions?

Transcript

Hello and welcome to this webinar about leading your midstage startup through the new normal. My name is Roland Siebelink and I’m the founder and the CEO of Midstage Institute, and we help midstage startups thrive through the good and the bad times. Today, I want to talk about how the world has changed since the valuation of startups started dropping precipitously in Q2 2022, and what that means for your startup and how to respond to it.

Let’s get going. The presentation is divided up into five key parts. What is the new normal? What is it and how long will it last? How do you maintain credibility as a leader in leading the change? How do you ensure survival of your startup by focusing on the core? How can you extend your runway, typically by making some hard decisions? And then also, how can you thrive long-term by focusing primarily on the differentiation that your startup provides?

Let’s start with section one. What is that new normal and how long will it last? Just to provide our conclusions a little bit upfront - and I’ll talk about why in a second - we do think the economy will recover. Inflation will come under control. But lower valuations for startups will persist for a while. Why do we think that? Well, the economic fundamentals actually look better at evaluations at the moment. This is not the 2020 COVID cycle when we were expecting a huge crisis and valuations turned up higher than before just because so many people were forced to work from home or learning to work from home; therefore, there was a big demand for new technology tools. We cannot expect valuations to return to 2021 levels soon. Also, because of historical benchmarks that we have seen in the years - for those of us who’ve been around a little bit longer.

The employment statistics, especially around the world, are far more positive than expected. There were first signs of the US inflation getting under control, as we’re recording this in September. The last figures were still a little bit higher than expected but still lower than what was expected about a month or two ago. I would say even though it’s a little bit slower, these signs of inflation getting under control are still there. And we have seen some stock market gain, even some interesting exits from the likes of Figma being bought by Adobe for double the valuation that they had achieved last year.

However, in general, tech valuations still seem relatively low. That is only low if you compare that to very recent valuations, such as done in 2021 in the middle of that COVID boom. What we think often is that it may be just a sign of them reverting to a longer term average, especially when investors are a little bit more worried about the value of money in the longer run. And therefore, want to discount risk more and the opportunity to gain huge revenues in the far future is worth less than money that will come in sooner. In a way, the new normal is the old normal pre-2012. Expectations were a bit higher when people wanted to see money sooner. Generally, startups got a decent valuation but not crazy valuations like we’ve seen in the last year.

In this case, investors are looking more for actual results over speculative results. And this is a framework that we sometimes use to explain a little bit where you play as a tech startup in the minds of investors. To explain this two by two, we can say that there are only four ways in which investors can see value being driven by their investees, by their portfolio companies. The portfolio company can create more upside or can reduce the downside. And both of these can be split up in speculative ways of reducing downside or increasing the upside or actual hard number ways. And we think that this is a cycle that companies go through in their life cycle. In a very early stage, you focus on the speculative upside, essentially because you have nothing yet, so all you can do is sell the dream, sell the vision, imagine a world in which we were to conquer a billion customers and they would each pay us $10 a year - how much revenue would that be? That is what we call increased opportunities - irrational exuberance is the code word there.

And many early stage startups, pre-seed startups, play entirely in that field. Even those that are funded with a lot of backing from startups may for a while still have a big component in increasing opportunities. After you actually start selling, then - as every founder knows - suddenly sales become the most important. What you’re really selling is outsize growth, much faster growth than what the market will bear or the economy in general. And while you may still have some increased opportunities in the back of your deck, what investors care more about is that increase sales, and especially the sales that are coming down the pike, the growth rate and how far that growth rate can be projected into the future is the part that investors value very, very highly.

Sometimes that goes so speculative that you’re almost getting back to that top left quadrant of the irrational exuberance. We will have growth rates doubling from a very low base but 10 years down the road. That is the part that’s now getting a little bit less attractive to investors because that money may be worth a lot less in the future.

This is why in a third phase typically, they are less eager to start paying for growth. In a time when money stays very valuable over time, just getting people to buy customers, to spend a lot of customer acquisition costs just to gain market share is attractive. But if you buy all these customers at a non-profitable rate and you have no foreseeable path to actually get them to profitability, soon investors start moving to the third quadrant and they say, “Can we reduce cost?” It doesn’t mean they don’t wanna see growth anymore. They just wanna see profitable growth or growth that gets to profitability sooner. Increasing margins, typically on the customer acquisition cost, and then over time, some of the overhead and even R&D will also have to live more by their means, so that the company can get default and afterwards structurally profitable.

And only at a very late stage will that reducing cost actually become the main refrain. Mostly, that is not something we see at startups unless they are in very big crisis mode. Even then, it’s typically only for a short amount of time like when a reduction in force needs to happen or the startup needs to reset itself so that it can focus on growth again. The companies where reducing cost becomes more the structural part that they play in are the companies that are more invested by private equity, companies that are in a maturing life cycle that are losing market share where reducing cost is the game they have to play to stay alive. Of course, companies that are at the end of the life cycle, often it is about stable returns, reduce the risks, do not do anything to rock the boat, which explains the mindset in some of the very mature companies that we try not to work with and the kind of people that work there like to avoid any risk to the franchise that they have.

All of these are valid, but for a startup and for a founder, it’s important to realize where you are playing, can you sell all your valuation purely on the basis of increased opportunities or are you actually increasing sales? And if so, can you do that at a profit or at least at reduced cost? That’s the framework that we want you to keep in mind.

How do you maintain leadership credibility in this new normal phase? For us, it means that as a CEO, as a founder, you have to show and communicate extensively how you are learning and adapting. Even if you are yourself still unsure of exactly what to think and what to do. And it’s perfectly fine to lead the change with a little bit of vulnerability. That actually helps to maintain your credibility. Credible leaders do reset their expectations. They embrace this new normal rather than resisting it. And they learn quickly how to adapt.

What that means is communicating profusely to their teams and with their teams. Maybe not so much trying to constantly get feedback, but just more top-down, showing very clearly whatever you’re thinking, what are you working on, what is a new insight? And this helps a lot. We see a lot of CEOs, for example, resorting to weekly videos that they send to all of their teams. Nothing planned or produced, just a few bullet points that they wanna share with their teams so that people feel like they are in touch with their leaders. They are open about their uncertainties and are not afraid to feel vulnerable about sharing some of these uncertainties. But they’re still project big belief in the future so that people can latch on to that and keep working hard for what will remain a very attractive company to work for.

A little exercise that we can do here is you, as a founder, as a CEO, as a startup person, as an executive leader, how would you rate yourself? Have you reset your expectations? Have you embraced the new normal? Have you learned quickly or are you learning quickly how to adapt? Are you communicating profusely with your teams? Are you open with people about your uncertainties? And do you project belief in the future? Give you a minute to score yourself on this.

The best CEOs we work with typically score four or five - almost nobody scores six right from the go get. Of course, we want to get them to a six. Those that score three or lower should probably talk to their coaches or give us a call and see how we can work together to get you to that higher level of credibility so that you can remain in charge of your startup, even through these tougher times.

How do you ensure survival in this winter time? Winter is coming. We’ve been warned by Game of Thrones about that for a while now. The answer is to strive for default alive. And how do you do that? By identifying the core of your products, of your go-to market, and also of your staff or your employees?

Maximizing runway is about realizing that all the dry powder in the world that VCs are set to have will not save you. This dry powder is - first of all - not in the bank accounts of the VCs. It’s commitments from other investors, from limited partners, that might come to the fund if there’s a capital call. But which VC wants to do a capital call in a crisis? Who wants to come up with a really speculative investment that all these investors and limited partners will feel wary about? That simply doesn’t happen at this stage. The dry powder one is not really there. Second, the VC does not have the power to push for an investment at this stage. It won’t save you unless you have a very compelling business that everyone sees based on pure economics is the key to investing.

Preserving cash, therefore, beats growth at this stage. Of course, every startup is still a growth company, and growth is ultimately what gets investors excited. But at this stage, having a lot of growth that will drive you to unprofitability and make you go cash negative there’s no remedy for that. Preserving cash beats growth if you want to optimize survival.

Reassessing the bottom line contribution. Out of all your projects - if you were to split them up, do a bit of a waterfall chart - which ones are actually gonna be contributing significantly to the bottom line of the company, not just the top line, and which ones are a revenue driver but also a huge cost driver? Almost always, when we do this exercise with startups, midstage startups, they will talk about their three business lines, and they will say, “Well, we can’t really drop any of them because one of them generates 20%, the other 30%, the other 50% of revenues.” Once you start looking at cost and profit, however, very often the first one generates 90% of overall profits, the second 10%, and the third one brings all that profitability down to zero again just by the huge cost to generate. Those are the ones that we cannot afford at this stage when the winter is there. And that’s how we want to reassess the bottom line contribution.

Can you get to a 24-month runway? That’s what many investors are asking for right now? How aggressive can you be in slashing your burn and getting up to 24 months that you don’t have to raise money? And how fast is your path after that to a 30% free cash flow, which is the gold standard of becoming a very attractive company that is default profitable and can survive by itself.

Extending your runway means dropping the loss leader. I mentioned this example that we see at many, many startups. For example, the revenue contribution in this case was 72, 20 and 30. It looked like we cannot cut any of those without significantly driving down our revenue. However, if you looked at the profit contribution, you saw that products one and two were actually profitable and getting to a net income for the company. If only it hadn’t been for product three, that only basis of just 30% in revenue was generating 90% in cost and therefore is driving the entire company in cash-negative territory. That’s the kind of loss leaders we want to identify and then think, can we still afford those.

Extending the runway until good times return means making the hard decisions. You have to call C players. You have to let go of the loss leaders that we mentioned. And also, defund the most speculative ideas that are not yet going to give you a return in the short term.

Hard decisions. One of the CEOs said hard decisions are like vacuuming; if you don’t do it often enough, then it just piles up. And in the end, it just becomes a lot harder. But these times, these crisis times, these difficult times, are also the best times to sometimes take hard decisions that otherwise wouldn’t have been acceptable to your team.

Something that you can do really quickly is to call C players. Very often, we work with clients and have the executive team go through the list of all the people reporting to them collectively and say, who are the best people that we have here? Who are those that have had a few warnings about their behavior? Who are those that are never performing? And can we identify those that do not add value to the company, maybe add more friction and cost and frustration to the company? Why are we still having them on the payroll? Wouldn’t it be time to set them free and let them find a better future somewhere else that’s also better for their own career?

Letting go of loss leaders. That’s what we talked about in previous sections. Understanding which product but also sometimes which region or which department or another activity is causing the company to generate so many costs that wouldn’t have been necessary if that whole department or product or region did not exist. Also, defund speculative projects. We see a lot of this in product and engineering. Things like future product lines, marketing experiments, long-term learning development, all those investments in the longer-term future are probably things that we should at least cut for now and wait until the good times return to start funding again. As Winston Churchill used to say, “Never let a good crisis go to waste.”

Employee forces or employee groups always have players holding folks back. I mentioned this already. And the framework we like to apply is, is it people that exemplify company values or do they act against company values? Also, do they perform average in this role or do they perform over average in this role? C players are those that are clearly acting most often against company values and only perform average in a certain role. I wanna warn against using other frameworks that people have come up with. The one we see a lot is not just current performance but also potential. We have not often seen a very objective assessment of potential in the role. Very often, potential is used more as a way to express liking or disliking the person. And since it’s often the manager themselves grading that person, it’s also a way of saying, “Well, they haven’t performed yet, but I hired them with good insight anyway because I think they can do better in the future.”

Whether they have potential or not should not be the key question at this stage. What we should assess is are they performing in the role that we pay them for? And do they actually fit with the company? If they have more potential, then you can always put them in a different role and then assess whether in that role they have the potential. What we cannot afford at this stage is people underperforming in a job and then saying “Yes, but they might still grow into it.” Identify those people that act against company values and only perform average or below in this role, and then wonder why are we holding the good players in the company back by forcing them to work with these people?

Where do you thrive in the mid to the long term? Assuming you’ve been able to ensure your survival, assuming you’ve been able to extend your runway by making the hard decisions, you should have a better feel for what is your true core, what is the business that is gonna keep putting the bread on the table and how do you secure that franchise to thrive long term. The key is to optimize that core for break even and then focus long term investments, not on building new cores but on further differentiation from potential competitors.

We think that at these stages, optimizing the core should be for break even - or what Y Combinator calls default alive. If in that very core, you cannot even make a profit, you have to be very careful in understanding why is my business model not yet performing? How can we get to at least keeping that default alive?

In your product investments, there’s gonna be some crown jewels, as Geoffrey Moore calls it. Those are the key parts of your product that deliver the value, what delivers the aha moment to people. Often, already a source of differentiation, so do protect those with further investment but minimize and outsource any activity or feature set that is actually just a we-also-have-to-do-this activity, something that’s non-differentiated.

Once you’ve been in business for a few years, there’s gonna be customers that stay with you no matter what. And that’s actually an opportunity - a very well known strategy - to start milking those older products. What that means is to defund further investment - do not try to optimize them all the time but just keep them running at minimum cost. And potentially, you have a chance to start adding in some price increases. Especially if customers are relatively dependent on those products, you start having pricing power. And this pricing power can help you fund future product investments that increase your differentiation.

Try to add fewer people back. You’ve just done a bit of a clean up and gotten rid of some C players. Don’t try to replace all of them. Just try to pay the best ones more. Over time, many companies start getting smarter by not throwing more hot bodies against the problem but trying to identify who’s best at solving that. And now what do we do to keep those people here and keep them happy? Ultimately, move the leadership burden from just the founder to the full executive team. This is something we work on with many startups, helping them understand let’s have a team run this business. Yes, of course the founder/CEO is still in charge and makes a call when they cannot agree. But in surprisingly many cases, people can actually agree, can come up with creative ideas, and actually can run much of the day-to-day business without the constant involvement of the founder/CEO. Thereby, liberating her or him to look further in the future, focus more on bigger strategic partnership, and maybe even work toward an exit at some point in time.

Some tips on moving that leadership burden from the founder to the executive team, something we do in many of our workshops. We help the founder write out the vivid vision. We get executives to buy in and contribute to that vivid vision. Then we start agreeing on momentous goals. Momentous goals that are on a three-year time base and breaking that down in one year-time base, and then even into quarterly OKRs.

As external facilitators, it can be very helpful to do that from a neutral point of view so that the CEO is not at the same time trying to drive that leadership burden down and also managing the workshop because that is a little bit incompatible with each other. We funnel ideas into offsites. In other words, do not try to jump on every new idea as soon as it comes - oh, we gotta do this, and there’s another squirrel and another shiny object there. It’s fine to be creative and keep a list of those ideas. But let’s not prioritize them until we’re all back together at a new quarterly offsite, and then see which of the things should drop off of our list compared to this new shiny object that might actually help the company do better.

We try to put everything together in what we call a one page strategic plan and then drive out of that a quarterly delivery rhythm. Between those offsites, everyone is very clear on what needs to be done, who’s gonna be evaluated on what result, and in the meanwhile, you do not have to worry about new ideas coming up and having to respond to it.

This is what it looks like; a very simple version - the Verne Harnish version of the one page strategic plan - starting with core values on the left. And as you can see, totally breaking that down into the three-year, one-year, and quarterly plans. And then even breaking that down further into what’s the theme for the company, as well as my own accountability that comes out of this. We typically help draw it up 80%, 90% of this in a first workshop. And then it’s all getting better from there.

Conclusion, leading your midstage startup through the new normal means first understanding and then embracing what is that new normal. We think the economy will recover and inflation will get better, but lower valuations will persist for a while. Do not stick to expectations of 2021 lasting forever. Can you maintain your leader credibility? Our advice is to show and communicate how to learn and adapt, even if you are unsure.

Third, what will ensure survival of your startup? Striving for default alive in the expected phase of no funding is the best way to ensure survival. How can you then make your runway last longer? Our advice is to call C players, slaughter some of the sacred cows or the loss leaders, and cut speculative investments that will only pay off in the long run.

And where do you then thrive in the mid to long term? You optimize for break even and share the leadership burden with the executive team.

That’s our advice in leading your midstage startup through the new normal. If you wanna discuss your own startup with us, then feel free to book a call. Our strategy calls are free and you can book them on www.midstage.org/contact. Looking forward to talking to you all soon.

Roland Siebelink talks all things tech startup and bring you interviews with tech cofounders across the world.