Most founders think they know their metrics. This post will tell you they don’t. It will reveal the most overlooked metric among startups. A metric so important that many startups fail because they don’t track it. This post will help you not make that mistake. Use it.
One of the biggest disasters in human history was unfolding. Panic spread like wild-fire as people realized they were doomed. When it ended, more than 1500 people had suffered a gruesome death.
Two hours and forty minutes earlier, First Officer William Murdoch had taken over command. He couldn’t believe how lucky he was. He was steering the largest and most prestigious ship in human history. The RMS Titanic.
The water was calm as glass. The air was so clear that the lookouts didn’t even need binoculars. In such conditions threats could be spotted on eye sight. And the crew would have plenty of time to steer around any problem ahead. During the next 30 seconds, First Officer William Murdoch would learn he was mistaken.
At 23:39, the lookouts spotted the iceberg. William Murdoch didn’t panic. He knew exactly what to do. He ordered the engines reversed. It would reduce the speed enough to steer the ship around the iceberg. He knew because he had been sailing for 12 years.
But William Murdoch was about to learn a new lesson. The RMS Titanic was different. And he didn’t have enough time. Half a minute later the iceberg ripped the ship open and unleashed a true Armageddon.
The lesson: Knowing the stopping distance of your ship is rather important.
Startups sail in dangerous waters
Early startups differ from established companies. And the difference can conveniently be illustrated using ships as the analogy.
A company is like a cargo ship carrying goods from one port to another. It sails a fixed route in a well-known environment. It’s low risk and the reward is predictable.
But a startup is like a treasure ship in unknown water. It often changes direction and must avoid all the icebergs floating around. It’s extremely risky but the reward can be massive.
In the world of startups, the most common iceberg is this: Premature scaling.
Premature scaling is so common that is basically synonymous with failure. Premature scaling happens when the founders decide to employ more people and increase marketing spend too early. Too early is before they have found product-market fit.
The result of premature scale is this: Cost increases more than revenue. The bank account sinks until there is nothing left. The empty bank account is the iceberg. And the engines must be reverse early enough to change course. First Officer William Murdoch of the RMS Titanic would agree.
The importance of the scale down rate
All startups meet icebergs. Like an online game called Glitch. The team raised angel funding. Then series A. Then series B. For every round they hired more people. The costs exploded. The revenue didn’t. The iceberg was approaching rapidly.
The team decided to reverse the engines and change direction. They survived, succeeded and eventually found gold. Today we know them as Slack.
But the story of Slack isn’t unique. In fact, most startups experience the following in some form: The founders have a vision. Investors fund them. Founders take salary. Costs increases. Revenue is lacking. Founders raise more money. The team grows. Costs increases even more. But the revenue is not picking up.
The founders try to raise more money, but investors are becomingly increasingly unwilling to fund them. The iceberg is approaching. And at this point, founders need to know their most important metric. The scale down rate.
A good scale down rate
All founders should track their scale down rate. It must give an updated and accurate measure of the stopping distance. How fast can you eliminate costs to a sustainable level? Most founders don’t know.
The scale down rate is a function of the structure of your agreements and liabilities. Such as, employment terms, loan terms, payment terms to suppliers, access to credit lines, etc. Ideally founders must seek to structure these agreements with respect to their stopping distance. The stopping distance is how long it takes to eliminate costs to operating breakeven levels.
Founders must optimize for flexibility in all agreements. Have the option to delay payment against penalty. Hire people on flexible terms. Decrease monthly salary and replace with end of the year bonuses. Avoid lengthy office rentals. Get a credit line. Keep savings so you can defer salary for a period of time.
What is a good scale down rate? It depends on the icebergs in your water. Delayed funding rounds are relatively predictable. But founder breakups, Google ranking penalties and bankrupting key customers can come sudden. Assess your unique environment.
A rule of thumb would be 1% per day. If you can slash 50% of your costs in 50 days, that should give you enough time avoid most icebergs. And every time you do, you get another chance of finding gold.
- Most founders don’t track their scale down rate.
- Most startups will experience the need for rapid scale down.
- Most successful startups have succeeding scaling down and pivoting to something else.
- If startups don’t know their scale down rate, the risk of losing everything when critical problems arise is very big.
- A good scale down rate is different for each startups.
- A rule of thumb is 50% of the costs in 50 days (1% per day).
Check out Accelerace. We invest in tech startups.