September 24 2014
by Todd Hixon

Is It Time To Step Up The Burn?

[This post first appeared at on September 17, 2014.]

Fall is the season for laying out next year’s strategic plan. I have several companies in my portfolio that are off to a good start and facing the decision to double down next year by spending a lot more money, or not. Prominent VCs are speaking up about venture backed companies taking too much risk by spending too fast (especially in Si Valley). This is a big decision for all concerned. Here’s how I think about it.

My companies are at the stage where their products are working, they’ve had success with a few major customers, and they are near breakeven on a modest expense base. We’ve had enough success that we’re confident our vision is real: we can disrupt the industry. Competitors are seeing the opportunity we see and beginning to enter the market, so we feel urgent need to scale up and build a dominant position, e.g., to become the “Uber” of our industry. However, the senior management team is still landing most of the revenue. And the business model is a bit fragile: questions remain about how we will scale the business profitably. Should we table a plan to grow 3x-5x next year and set out to raise a big financing round to fuel the growth?

New investors will ask tough questions. The business model is the first issue. Do we have strong incremental margins (the ratio of gross margin to revenue for the next group of customers), well-understood customer acquisition costs, and proven ability to scale volume with known and controllable investment?

We need to look hard at our experience to date, with focus on the part of the business that forms the basis for future growth. If the business model is weak and needs to be overhauled, then a big growth investment is very risky. We would be trying to fix the engine while passing on a windy two-lane road.

Market size validation is the second issue. Yes, we have some business, but are we “crossing the chasm” from the few early adopters to a broader group of mainstream customers? Is our estimate of the market size confirmed, or better yet expanded? How ready is the product to address the broader market, and how much time and money will it take to get there?

The third issue is the go-to-market model. So far, the CEO and top team have driven our success hands-on, and each of our key customer relationships works a bit differently. Doubling down means hiring a sales team to carry this forward away from the hands and eyes of the top team. Can we create a sales model, based on product, targeting, pricing, sales tactics, service/support, etc., that works in the hands of mere mortals? And given that the success rate hiring sales execs is rarely above 50%, and it takes them 6+ months to become productive (or not), what does a realistic revenue growth plan look like?

The fourth issue is management bandwidth. Until now we have been running a very focused businesses. For next year we are looking at businesses that will be much more complex in terms of products, customers, or geography. Do we have the team we will need? Is the CEO ready to raise his/her game and run a more complex business [an awkward question that new investors will definitely ask]?

VCs who have worked with many companies over many years are fond of saying: “I’ve seen this movie before, and I know how it ends.” My personal experience says that companies ramp up the burn too soon far more often than they ramp up too late, or put another way, it’s rare that a company looses its market opportunity by failing to expand soon enough, and it’s common that a company runs out of cash because it built up its burn rate but could not grow revenues fast enough. Execution is harder than it looks, and markets usually take longer to develop than visionaries expect.

And, the penalty for getting this wrong is big. If the company runs out of cash with a big burn rate it might shut down. Otherwise, it will be forced to raise money at a disadvantage and pay a steep price in equity dilution. Some key managers may lose their positions. So, some caution is in order here.

I like to ask the team this question: how much growth do you know how to deliver? I usually focus on the revenue side, where the risk is often greatest, but this question is equally apt on the technology or delivery side, if that is the limiting factor. Then I drill on the assumptions and logic behind the answer, focusing on the four issues above.

At the end of the day, venture is about the upside, for everyone: founders, managers, LPs, and GPs. The ~20% of portfolio companies that do really well provide all of the economics; the others fade away. If we fail to build these companies, we have accomplished little. But, 80% of companies fail because the bar for success is fundamentally high. The decision to double down and ramp up the burn is a moment of truth. If you’re not ready, face facts, and keep working at a low burn until you find a way to put the enablers in place: this keeps the option on the big win alive.

But, when the market opportunity is proving out nicely, we believe we know how to go get it, and we have a realistic well-thought-out plan, then it’s time to take the plunge and go for it.

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