Running Lean Versus Starving a Startup
Rob Day visits some Israeli tech startups and learns that there’s a fine line between running lean and starving.
Heading toward Jerusalem from the Tel Aviv airport, my taxi driver suddenly took both hands off the wheel to wave around and point to his phone. “Do you know the application ‘Waze’?” he asked. Quickly, I assured him that I did know it. To my relief, he put one hand back on the wheel, and went back to talking about the U.S. presidential race.
I was there to meet with my friends at Israel Cleantech Ventures (ICV) and to visit with several of their portfolio companies, as part of a limited partner meeting. It was only a brief visit, but it reinforced the lesson from Waze’s successful history as well — that you can grow great startups in a lean way. I visited several no-frills startup headquarters (no bean-bag chairs, personal chefs, or other “unicorn” style perks in evidence), and heard a lot about revenue-generating business models that involved providing a full solution to various global markets. Not a lot of single-component innovations waiting for value chains to adopt them, in other words, but full-on products and services delivered to markets as efficiently as possible.
For example, there was Vayyar, which is leveraging a proprietary 3-D sensor technology for a number of applications. One, for easier and less expensive breast cancer detection, is being targeted initially for some emerging economy markets, and not the U.S. Why? Among many, one important reason is that those markets are faster and less expensive to break into. It was a pragmatic take on a medical device market-entry problem that is often tackled instead with lots of venture capital.
Or take Nova-Lumos, which is delivering solar power services for off-grid and unreliable-grid parts of Nigeria. The company’s team showed off a simple solution to such a complex market need, with a very basic, remotely tracked and administered system designed for the users to self-install easily. A big boost for the company is a $15 million credit facility it has closed with OPIC to deploy 70,000 units.
One other striking example I learned about wasn’t actually a startup per se, but a nonprofit. Leket Israel gathers tens of millions of pounds of food that would otherwise be wasted, and redistributes it within the country to people in need. It started out with the founder gathering up food himself in his car’s trunk and storing it in his own home’s garage. But over time, it grew, and the nonprofit was able to leverage what is now a network of 55,000 volunteers, 1,000 farmers and over 180 other regional nonprofits to help 35,000 needy families last year.
These examples show that it’s entirely possible to build a rapidly growing startup in a lean way, leveraging non-dilutive resources and simply not spending much on frills or complex go-to-market strategies. Israel’s entrepreneurial cluster may have some special characteristics in this regard, but it’s part of a pattern I’ve seen in other regions outside of the VC-dominated areas of Silicon Valley and Boston, among others.
It’s a pattern that cleantech startups should be emulating as much as possible these days as well. It’s easy to get sucked into seeing what’s going on in other parts of the startup world and feel like showing “momentum” (the lifeblood of venture-backed startups these days) means having to show some kind of gravitas via nice office space, or to compete for talent by throwing perks at people, or simply to over-hire in hopes that the extra capacity will mean faster development and growth. Instead, think of the startup I visited that’s currently sitting on over $20 million in cash but whose headquarters required clumping up several flights of stairs because the building was so charmingly low-budget. That same startup has the resources, however, to tackle a new opportunity when they see it, and to keep growing quickly.
On the other hand, I’ve also been seeing a lot of cleantech startups lately that have been put on austerity programs by their increasingly tired investors. Investors and boards who, forced to do inside financing rounds thanks in part to the sector’s out-of-favor status, thus mandate that the startups spend the smallest amount of capital possible in hopes of scraping by to some next stage of development — to some chance of raising external capital or to get to self-sufficiency. It’s part of the mercurial nature of venture capital, where the investors go quickly from “Grow! Grow! Spend money to grow!” to preferring that the startups don’t spend any money at all, if possible (and it rarely is). The startup is asked to come back with as low a budget as it can conceive of, which is then beaten down some more, and the insiders fund just that amount and no more.
These startups often do limp along. But such extreme starvation, which is often undertaken with an explicit goal of reducing risk, actually in my experience adds significant risk to the company.
First of all, as I mentioned, so much of what determines success in venture-backed startups these days is momentum, or at least the appearance of it. Turning down the dial on these startups so dramatically does often kill this. The budgeting and planning becomes pretty myopic. For example, I’ve seen board members urge not hiring new salespeople because it’ll take a few months for those new hires to get trained up to pulling their own weight. Of course, over a long period of time, if you don’t add those salespeople, you don’t grow. But if your budget horizon is six months because you’re hoping to “bridge” to a new funding event and are trying to save every nickel along the way, maybe you just tell yourself you’re delaying those hires. But over time, you don’t have the growth outside investors are looking for.
Also, word gets out that the company is reducing headcount, or at least not hiring anymore. Strong performers inside the startup may start looking around for new opportunities. Strong leadership may still keep people focused on success, but quite often I see people “toughing it out” and hanging around to support their colleagues. That sense of excitement and possibility that drives the enterprise is often lost along the way.
Second, the board starts to get out of alignment with the management team, with the rest of the capital stack, and with each other. It’s easy for everyone to feel roughly on the same page when everything seems to be going up and to the right. “More of that, please” is the agreed-upon status quo. Once the board starts forcing the management team to simultaneously broadcast continued momentum and yet also save every possible penny, the management team’s strong motivation is to start “messaging” their investors. There’s an erosion of trust, even among a group of high-integrity individuals, as asymmetric information and diverging motivations start driving communications. “We can’t possibly cut any more engineers,” the CEO says. “You have to,” the investors reply. As the impacts are often difficult to quantify and analyze, it becomes a frustrating decision-making process for all involved. This is often exacerbated by the preferred-equity structure of most venture capital deals, since the management team is probably holding common shares and needs a big outcome for any of those shares to be worth something, and yet the VCs may be looking at their preferences and just playing for getting most of their money back.
Third, no matter how well you try to budget, stuff will happen. A hiccup along the way can be greatly distracting as the management team spends a week suddenly trying to meet payroll rather than focusing on their longer-term strategic priorities. Two hiccups coming close together can be deadly. And the stress of the situation becomes very unhealthy for individuals and for the startup overall. I’ve seen some otherwise smart people do some incredibly stupid things under the pressures of trying to grow companies while being “drip-fed” the minimum amount of capital necessary.
Basically, running startups lean is an ambiguous term; there’s a fine line between running lean and starving.
I love seeing startups that make it a part of their culture from the beginning to be no-frills, to avoid over-hiring, and to be super-pragmatic about their market entry plans. It means that all the passion and excitement felt at those startups is around the growth in actual revenues and profits, not around status or “rah-rah” leadership exhortations.
On the other hand, when a startup does need to go into “hunker-down” mode and dial back spending, I think transparency and over-communication among the board, the investors, the management team, and the entire startup employee base is key. When interests seem like they’re starting to diverge, people should just be upfront about it, so they can talk through it. The investors should be explicit about how much capital they can put into the company, and what milestones they need to see in order to feel comfortable doing that, and stick to it. The management team should be forced to take on a “zero-budget” approach to justifying all expenses, but with explicit agreement between them and the board about what milestones (growth, strategic or otherwise) they’ll still be targeting as part of that budget, with some cash buffer included so that a couple of hiccups can be smoothed out along the way. “Fish or cut bait” deadlines should be identified and stuck to. And if it’s clear that some pain will need to be endured (i.e., capital and/or organizational restructurings), they should be taken on forthrightly and early. Far too often, under the stress of the situation, I see people try to soften their words with each other, or to kick the can down the road in hopes that the most painful steps won’t be necessary. They almost always are, but delaying them can be deadly to the startup. In the effort to preserve shareholder value, the decision-making actually drives up the risks in hidden ways, and eventually most of the value dissipates.
Fortunately, as my visit to ICV showed me, the lines between “cleantech” and the rest of “tech” continue to be blurred. And that probably means the “cleantech winter” for funding may be nearing its end. That will be very welcome, if true! But even when venture dollars are again readily available to entrepreneurs in this “sector,” I would hope the lessons of scrappy entrepreneurs elsewhere are still adopted: Run fast, yet lean, from the beginning. Otherwise, when the belt-tightening time almost always eventually comes along, it may be too late.