8. April 2016–
Turning around a struggling startup
A high risk of failure is part of any startup’s DNA. Even those fast-growing companies that are subject to investors’ hypes sometimes end up in distress, with their founders being forced to resign as directors and shareholders finding themselves in dismay over their lost investment. On occasion, founders and investors even continue their business in court. However, not all companies that are about to fail wind up in bankruptcy. At times, investors exchange the founding management for a seasoned interim-CEO, who has a track-record in putting distressed companies back on their feet.
Such situations can also arise when a startup is developing into a profitable, medium-sized company rather than into the "category killer“ that the founders promised during their pitch. On its way to a mid-market player however, the company becomes increasingly less interesting to business angels and venture capital funds who bet on occasional high returns rather than just about making their money back. And as any founder won’t make a dime before all investors have been completely refunded, they mostly lose their motivation as well, especially when a large amount of equity has been raised before. So in the end, nobody cares enough to get their hands dirty by tackling an ugly turn-around.
Thus, distress is often caused by an idle management that has failed to develop alternative strategies for slow growth scenarios. There is a point in any company’s lifecycle at which things other than revenue growth become important, so the top priority of growth should be frequently scrutinised. This way, founders can avoid bad press and if they’re smart even profit from an exit at less than the last round’s valuation – but only if they make the turn-around happen themselves before they get sacked by their shareholders.
So how does this work?
1. Set up efficient structures from day 1
The most powerful lever in any restructurer’s toolkit are HR costs, especially when taking over startups after a high-growth phase. Probably the most prominent reason for a skyrocketing payroll are founders incapable or unwilling of surrendering control over daily business. If you want to be in charge of every bit of value creation, you will be buried with work. Thus, you might get the impression that you need more employees to deal with all that workload – when all it really takes is proper delegation of responsibilities.
This means: structure your own work and set up clear and well-documented processes for your team. Rule of thumb: if you have to get involved with daily business every day, something’s wrong. Early on, it’s hence one of the most important (and challenging) tasks of a founder to hire, motivate, develop – and retain – a strong executive team that you can trust with running your company. Besides that, every company needs a set of standards and procedures.
The simplest example is a request form for time off. It governs all vital questions (which employee, when, for how long, who is in charge during their absence, how much vacation remaining). It gets more complex when a company’s budget is divided across several cost-centres and has to be matched against actuals on a quarterly basis. Long story short: as a founder you have to surrender more and more control to your organisation the larger it gets.
Such procedures can only be enforced by the founder as the transformation of a startup to a grown-up enterprise can be painful for many team members. But it’s a pain every founder has to go through – a company with 50 employees can’t be led at the foosball table.
Another reason for exploding headcount is founders’ egos. Often, an army of new hires starts within the first weeks after first investment round’s closing. Of course, hiring is easier than growing revenues, order numbers or downloads. Last but not least: fast hiring often leads to a drop in the quality of your team. This leads to high turn-over, which makes it even harder to foster structures and procedures.
During internationalisation, another grave mistake frequently occurs, when responsibilities between headquarters and subsidiaries aren’t properly aligned. Not only does this give rise to politics and behind-the-scenes-fighting within your team but also to inefficient decentralisation of tasks (which is basically the opposite of economies of scale). If your company has eight country offices, each with a proprietary performance-marketing and design-department, you’re probably not operating efficiently.
2. Plan B – Alternatives to growth?
If you’re rigging your company for high growth, you’ll need a larger team than if you’re optimising your profits. Therefore, every founder should sit down with their accountant or CFO and devise a plan B organisational chart – as you might end up on a lower growth trajectory. This plan B should contain the absolute minimum team necessary to keeping the business alive (not developing it further!). For this task it might be useful to get help from the outside – insiders tend to be too generous. Of course, all of this holds for all other costs, but HR commonly bears most potential for cost-cutting.
One more thing: If you’re not yet selling anything, you should start thinking about monetizing what you have as soon as possible. Without revenue, there’s nothing to turn around.
3. Transparency towards your investors
No company suddenly stops growing. Your KPIs will show you early on when you run into chop, interpreting them is one of your key tasks as a founder. Up to a point, weak KPIs should certainly be seen as a challenge rather than a problem. However, if for example customer lifetime value never ceases to be lower than the cost of customer acquisition, pushing for further growth may not be the most sustainable thing to do. Those who arrive at this conclusion should openly and directly communicate this to their investors at the earliest possible convenience. You shouldn’t expect your investors to interpret their reporting package for themselves – if you do and things go wrong, investors tend to get angry with you as the CEO.
It's usually best to communicate negative developments as early as possible because even if your company ends up being bankrupt, you won’t be the guy who burnt all the money without even thinking about it. Even better: investors may support alternative strategies if you suggest them. For instance, a strategy shift from growth to profitability may make perfect sense, as cash-flow positive companies are attractive for small- and mid-cap private equity funds, who are looking for a strong, incentivised management team (congratulations on your first management buyout).
You may even succeed in these situations if your first investors don’t make all their money back. It may not be pretty but venture capital funds intentionally take high risks, thus they plan for things to go wrong. And any investor prefers a bad return to none at all.
4. Transparent and decisive execution
You’ve worked out your plan B, your investors are on board with it, now you have to execute on it. There’s only one way to go and it’s quick and easy. Your company and team are facing rough times as it is. The most common mistakes are the following two: 1: Founders are scared to tell the truth, which isn’t helping anyone but their own complacency. This way, they shake up everyone and unnecessarily frustrate those team members whose position is secure.
2: Founders stop restructuring halfway, when the company is barely self-sustaining instead of further optimising its profitability. Look at it from a strategic perspective: it’s great not to be broke, but you can’t sell that. If your growth story turns into a fairy tale, your company value will be determined by operating cash flow only – and that requires sustainable profitability. It’s never easy to let employees go – but if you have to, do it right.
All these suggestions hold for founders who have everything going in their favour. Building a strong core team and efficient structures with well documented and monitored processes should be embraced by any founder. Furthermore, knowing how you can make your business independent from investors will make your pitches and shareholder meetings considerably easier. And maybe, you’ll realise that you’re closer to being profitable than you thought.
Sebastian Rave is specialised in interim management, regularly assuming leadership positions in digital companies during turn around, consolidation and growth situations. His clients include startups such as 8fit, Glossybox, Scarosso and Classic Trader.