There’s a nifty new calculator that every tech startup should have, although they might not like the feedback it provides.
The tool can basically determine whether a startup will live or die.
Y Combinator founder and partner Trevor Blackwell created the so-called growth calculator and fellow cofounder Paul Graham says it provides scary, but important answers about whether a startup is on the right course or not — or as he puts it, “default dead” or “default alive.”
Will the startup run out of cash based on its revenue growth? Or will it make it to profitability?
“The reason I want to know first whether a startup is default alive or default dead is that the rest of the conversation depends on the answer. If the company is default alive, we can talk about ambitious new things they could do. If it’s default dead, we probably need to talk about how to save it. We know the current trajectory ends badly. How can they get off that trajectory?” Graham wrote.
The “fatal pinch”
The calculator takes your monthly, weekly, or yearly expenses and assumes they stay constant. A startup founder can set revenue and by how much it is growing to determine how long it will take the startup to reach profitability — and how much money it will need in the interim.
The calculator assumes expenses remain constant, although many startups grow their headcount and expenses along the way. That’s why founders need to be constantly evaluating whether they are still on path to profit, or if they are by default dead and on track to being caught in what Graham describes as “the fatal pinch.”
The “fatal pinch” happens when a company is by default dead, can’t raise money, and doesn’t have enough time to reach the point of profitability. It can be saved by lowering expenses, which generally means firing people, or increasing revenue.
Ring the alarm
In the past few months, we’ve seen some startups implode after hiring too fast and not managing their burn rate. In August, Zirtual laid off its 400 employees in an email over night. Other startups (and big companies) are also taking steps like layoffs to stay on the path to profitability. Flipagram cut 20 per cent of its staff in October and Zomato laid off 300 employees. Bigger companies like Snapchat, Evernote, and Twitter all trimmed staff recently too.
In early startups, the problem is most often that the product is only moderately appealing and not the hit that it needs to be. While some companies start hiring to “build out” their product, they’re only really building up their expenses and possibly setting themselves on the trajectory to be default dead and caught in a fatal pinch.
“Asking whether you’re default alive or default dead may save you from this. Maybe the alarm bells it sets off will counteract the forces that push you to overhire,” Graham wrote.