Default Alive or Default Dead?

Author: Paul Graham URL: http://paulgraham.com/aord.html One-line: Ask early whether, on current expenses and growth, the company reaches profitability on the money it has — and if it is default dead, don’t count on investors, and don’t hire your way out.

Key claims

• The question: assuming constant expenses and the recent revenue growth rate, does the company make it to profitability on the money it has? Default alive → talk about ambitious things; default dead → “we know the current trajectory ends badly.” Ask it too early rather than too late.
• The fatal pinch is default dead + slow growth + not enough time to fix it — reached by not noticing you’re headed there. Separate the components explicitly: “We’re default dead, but we’re counting on investors to save us.”
• Investors are a function of growth and are fickle — over ~5x a year you can start to count on them, never more; fundraising can never be treated as a safe assumption.
• Growing fast vs. operating cheaply is a false dichotomy: there is surprisingly little connection between spend and growth. Fast growth comes from a product that hits a nerve; heavy spend comes from an expensive product or waste.
• How to avoid default dead: don’t hire too fast. Hiring too fast is by far the biggest killer of funded startups; founders overestimate the need, and VCs encourage it — “kill-or-cure strategies are optimal for VCs because they’re protected by the portfolio effect.”
• Hiring rarely fixes a moderately appealing product and usually makes it harder to evolve. Airbnb waited four months after raising to hire anyone, and spent that time overworked, evolving the product.

Notable quotes

• Default Alive or Default Dead? by Paul Graham
  • Assuming their expenses remain constant and their revenue growth is what it has been over the last several months, do they make it to profitability on the money they have left? Or to put it more dramatically, by default do they live or die?
  • 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?
  • I propose the following solution: instead of starting to ask too late whether you’re default alive or default dead, start asking too early.
  • The fatal pinch is default dead + slow growth + not enough time to fix it. And the way founders end up in it is by not realizing that’s where they’re headed.
  • Instead of thinking of the future with vague optimism, explicitly separate the components. Say “We’re default dead, but we’re counting on investors to save us.” Maybe as you say that, it will set off the same alarms in your head that it does in mine.
  • It would be safe to be default dead if you could count on investors saving you. As a rule their interest is a function of growth. If you have steep revenue growth, say over 5x a year, you can start to count on investors being interested even if you’re not profitable.
  • But investors are so fickle that you can never do more than start to count on them. Sometimes something about your business will spook investors even if your growth is great. So no matter how good your growth is, you can never safely treat fundraising as more than a plan A.
  • In any case, growing fast versus operating cheaply is far from the sharp dichotomy many founders assume it to be. In practice there is surprisingly little connection between how much a startup spends and how fast it grows.
  • **When a startup grows fast, it’s usually because the product hits a nerve, in the sense of hitting some big need straight on. **When a startup spends a lot, it’s usually because the product is expensive to develop or sell, or simply because they’re wasteful.
  • How to avoid being default dead: That one is easy: don’t hire too fast. Hiring too fast is by far the biggest killer of startups that raise money.
  • Founders tell themselves they need to hire in order to grow. But most err on the side of overestimating this need rather than underestimating it. Why? Partly because there’s so much work to do. Naive founders think that if they can just hire enough people, it will all get done.
  • Plus founders who’ve just raised money are often encouraged to overhire by the VCs who funded them. Kill-or-cure strategies are optimal for VCs because they’re protected by the portfolio effect. VCs want to blow you up, in one sense of the phrase or the other. But as a founder your incentives are different. You want above all to survive.
  • What the company should have done is address the fundamental problem: that the product is only moderately appealing. Hiring people is rarely the way to fix that. More often than not it makes it harder. At this early stage, the product needs to evolve more than to be “built out,” and that’s usually easier with fewer people.
  • Airbnb waited 4 months after raising money at the end of Y Combinator before they hired their first employee. **In the meantime the founders were terribly overworked. **But they were overworked evolving Airbnb into the astonishingly successful organism it is now.

How it connects

• Paul Graham
• Y Combinator
• Airbnb
• Burn Rate
• Fundraising
• Hiring
• Venture Capital