# Dalton & Michael: Save your startup during an economic downturn

**Author:** Dalton Caldwell, Michael Seibel
**Type:** Video
**URL:** https://www.ycombinator.com/library/Ed-dalton-michael-save-your-startup-during-an-economic-downturn
**YouTube ID:** 0OVSTWozvfY

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Dalton Caldwell and Michael Seibel discuss Paul Graham's essay "Default Alive or Default Dead." They share strategies to
cut your company's burn rate and keep your startup alive to see another day.

## Transcript

i remember we had this meeting um with a lot of our employees and we were like look we got three options we can die in two months we can try to get to break even or we can try to get this thing profitable hello this is michael seibel with dalton caldwell and today we're going to talk about whether your startup is default alive or default debt so this is a concept that was actually invented by

one of the co-founders of yc paul graham dalton do you just want to start by explaining what this means yeah i mean so to start with you should read his blog post it is excellent it is short it is easy to read and so you should read it but let me try to give you my crash course in it here's here's what he means by default alive default dead as founders we we like to ignore the truth a lot of the time and one of those truths are is my startup going to go out of business

right it's kind of an awkward thing to talk about you know you don't want to bring that up in polite company and so the point of default default dead is it forces you to be honest with yourself if i don't raise any more money am i gonna die am i out of business or am i gonna make it and default alive is different than profitable profitable means today i make enough money that i am profitable my bank account grows every month you sell with me default alive means i may be

burning money today but my growth rate is high enough on revenue that i will become profitable before my bank account goes to zero does that make sense and so if not a single other dollar of investor money comes into the business my growth rate is high enough such that i don't have to lose sleep that i'm gonna have to raise a round before i die and his point is this is a binary either you are default alive or you are not default alive thus default dead there's no third option here friends

it forces you to pin yourself down in your own mind right does that sound right to you michael did i get that right you nailed it and and what's interesting is that another yc co-founder trevo blackwell basically made a calculator that allows you to calculate this because you know i would argue it's easy to calculate but it's just nice to have a tool there where you could just input some numbers and we'll make sure that's linked to as well so i think that with this concept of default debt or default alive

what's so weird is how obvious it is like it's weirdly the kind of concept that like the entrepreneur who runs a barber shop will understand before a startup founder well right it's like it's it's so logical what do you think are some of the reasons why founders have a hard time understanding this is important math to do like what what's what's distracting them from this truth i think the context is it if you've raised some money say you're a yc company raise money demo

day the belief that you'll be able to raise more money it's hard to not take that for granted and you're like yeah yeah but but really once you started raising money you get hooked on it you know like you get hooked on the juice okay and so the idea that maybe you won't be able to raise the next round or that'll go harder than you want to say that out loud is almost a showing like it's like you're not confident enough like i think you i think it's awkward to speak of these things with your co-founders with whoever because

it's almost like well of course you can raise the next round like of course like we're gonna make it and so i think it's that man i think i think again we've both been founders i don't think you want to say this stuff out loud too much it makes it sound like you're worried or scared and you certainly would not want to admit this to your investors well i think that here's the tricky bit in my mind not only is it that this idea of like well if we question our ability to raise the next round are we not confident or are we going to psych some people out in our team and

make them not want to work here it's that plus raising the next rounds harder so you kind of get screwed both ways like like i think oftentimes founders believe that raising the next round is going to be like the last round even though they kind of understand that the next round there's a smaller pool of people who can do it they're investing more money so so logically it should be harder right like mathematically there are fewer

series a's than seed rounds and fewer series b's and series right and so but i don't think they internalize that and one of the things you talk about a lot in the yc batch is this idea that startups are series of mini games and the minigames change and get harder i think people weirdly think that this fundraising minigame doesn't change when of course it does look of course and sometimes it's easier when you have a great product and great design sometimes your next round is far easier to be clear yes we're not saying it's

always harder but and here's the big but it's a moving target and there's this thing called the economy yeah this is a thing called like investors who are people that are not within your control we don't know interest rates and so what you'll see is whenever there's like choppy waters the default dead people that we're banking on the next round being easy die simple as that okay it's in the companies that are default alive when there's choppy waters they

live and i think it's funny because i like your phrasing we can't tell you whether it's going to be harder or easier to raise your next round we can just tell you it's probably going to be different than the last one so you should be planning for a wider range of possibilities than same as last time and i think about this in terms of margin of error like last thing on the screen yeah the margin of error when your default alive is huge you can go out and try to raise around and fail and be fine there's huge margin for error and what's

funny i always talk about this imagine if techcrunch wrote an article about every failed fundraise it'd be that's yeah we're only reading about the successful one there's lots of failed fundraisers friends lots and lots and lots and lots the majority of fundraising the majority the vast majority so i think the folks that are just reading techcrunch think that most fundraisers succeed so you're getting a really warped view and so so again like bear with me so most of them fail well guess what if your default

alive all right like that's not good news that your fundraise failed but you can live to fight another day but if you're running your business tight where you have like three months of runway and you're banking that it's gonna work and it's you're running this thing super tight what happens if your fundraise doesn't work is you die i think about default live default ad is if you actually control if you're actually in control of your company and not outside parties i.e investors actually hold the key to your company

you're kind of working for your investors they're they're actually your boss when your default's alive you're the it's you're in control of everything right yeah it's kind of awesome it's a it's a question of agency over the outcome you know well in dalton we talk so much in the batch about leverage when it comes to fundraising and when i think about being default to live there's there's multiple levels of leverage one is confidence right if you don't need a deal man you're gonna pitch better like like

this that's the way life works like when you don't need something you're way more convincing than when you're begging for something um and then two leverage being the investor knows you don't need them so not only is your pitch better right the investor knows your business is stronger and knows there's going to be more competition to invest in your business and therefore is more likely to want to invest in your business so you get like double leverage whereas on the flip side if you run your business default dead you take two average hits like when you really think

deep down especially like you said when you're on low runway you're like [ __ ] if i don't threat this needle or this fundraiser we're dead a good investor can always tell whether the company's pitching them is going to die and even if you want to invest you offer worse terms or you put in sneaky you know there's all sorts of sneaky things ratchet investors can do yeah yeah not good by the way like i would argue that that's an investor being a good business person if they have more

leverage they should get more positive terms if you have more leverage you should get more positive terms so michael why why is this the thing that so many investors don't like us as yc partners telling yc founders why do they hate when we say this stuff out loud so much they're allergic to this advice you know i think that in general investors are allergic when we tell founders that there might be situations where their incentives and the founders incentives are not aligned perfectly it's yeah it's like a magic

trick we're like telling people how the magic trick is performed it's like a faux pas they don't like it why do they they always tell us to shut up when we tell people this they always tell and there's like and and i think it's also funny because they also always tell us like hey like we're funding your companies like you shouldn't be like you know like telling the founders not to have high burn yeah exactly like i pat your back you pat my back you know put all this together and it's like yeah but man we got to put those founders first and i think that

like the other thing that's really tricky and we were talking about this earlier is that unfortunately founders get caught up with this math around default dead default live because the math they use to pitch their company to investors is only a subset of the math they need to run their business and i think this point is really tricky like when you're going in and pitching for a series a or a series b so often especially in a good economy you're talking about top line revenue

you're talking about new accounts that you've opened you're talking about your month over month growth and often times you're talking about your head count your hiring plans slash the execs you've brought on so on and so forth like the that's the math that you're putting front and center that's the math that investors especially in good times over focus on whereas i'd argue when you're running your company those numbers are important but there's also your burn rate your retention how much your existing customer accounts are expanding your revenue expansion over time

those metrics are the ones that can better help you when you're trying to figure out how to make sure my company stays alive and i think this is where things are tricky is that in many ways investors are setting the agenda on what metrics are important for a company and the investors are a little biased like they they have they have a a point of view that might be not oriented around keeping the company alive and you know pg talked about this right what was pg's line on on this stuff

yeah um he calls this in the blog post killer cure where he just points out that a founder and investor have completely opposite incentives where as an investor with a portfolio of companies if you push them all to grow fast and some of them successfully grow really fast with a high burn and thread the needle and you know become uber or whatever and some of them completely explode like fly the plane into the side of the

mountain like fast and there's lots more fast out there it actually makes sense from a portfolio theory to advise people to do this because either way either it works great or it dies and goes away and you get to spend your time on something else but like either way it's explosive right it's explosive good explosive bad well and for a good fund that time is the limiting factor right not money yeah and board seats you're limited as a vc on how many boards you can sit on and so you don't want to set so so basically if

you're a vc and you sit on a board of a company that takes forever to get big with like low burn that's kind of boring and kind of bad for your career and look you look bad to your colleagues like there's all these dynamics that founders are not aware of um that's not a good move to be on the several boards of companies doing just okay versus if you're a founder and you're choosing between do you want a zero

literally zero or do you want to keep going and give yourself more time to figure out product market fit and maybe you can figure out an exit and make life-changing money yep then that to a vc doesn't matter at all like man that sure sounds like misline incentives right michael like massively so sometimes the investor in this equation is kind of is perceived by founders who haven't raised money yet is like demanding that the company grows or demanding the company burns a lot of money

as if they were the boss and i think this is a very bad misconception like i don't i think that's extremely rare for an investor to be demanding you to like burn like crazy i think that the horrible truth is that founders don't need much of a push oh it's like it's like how michael i hear you're demanding people to raise at high valuations yes exactly aren't you demanding why i am i'm i'm i'm i'm twisting their arms to

dilute less it's i'm so powerful i think this is the tricky bit is that like deep down inside every founder wants permission to blitz scale and that they're special and they're going to build the next big one and so if you talk to you know half a dozen people and one of them is like yeah i don't know maybe you should grow faster i don't know maybe burns on our biggest concern like that's actually the fly on the wall recording i wish you could have a reply on the wall it's like yeah you know these numbers i think you want to get these up but i don't know if burns my biggest concern and then the founder hears that and they're like we're going

it's time i knew it what did fast do they raised 100 million and they burned it in 10 months they got into a 10 million a month burn that's incredible i'm i'm actually super impressed you have to really try you'd have to be working pretty hard on it we certainly need a lot of recruiters you gotta hire a lot of people yeah cause like what else are they spending money on there's no inventory like if it was a hardware company i'd understand but there's no inventory like and it's it's

i assume they weren't getting offices it was during covid right so it's like i have no idea i just it's that takes effort is my point you don't you don't just wake up one day with a 10 million a month burn and be like oh you know we're cutting free stacks this spinning is out of control in these stacks we need to friends tricky so there's another concept in um this default a live default dead uh

article that was linked to it was another pg essay called the fatal pinch i think it's so interesting because we see this in office hours so frequently like it is so common that we will talk to a founder who's in the fatal pinch and doesn't realize it and it's funny because at the end of the batch you tell everything everybody a very simple concept it's basically stay lean until you have something and then spend money on growing it yet founders

inevitably get frustrated get tired get distracted and somehow always come to the conclusion that spending more money allows product market fit to happen faster and what's sad is that like probably at least for me more than 50 percent of the time i don't get the office hour before the founders decide to ratchet up the spend right as always when it's too late they're like yes i always get the office hour when they're down to low runway and they they're like

we're we're dead we're bleeding out you know plea please help and it's like if you would talk to me six months earlier we could have tied a tourniquet around your gaping leg wound and you'd be alive hell we could have saved the lag what's tricky is that if you find yourself even suspecting you could be in this situation like you need to do this math as soon as humanly possible right like you're probably too late to do this math in all cases and no one wants to do it because

it's too late because it's a buzz kill man no one like who wants to be that guy everyone's gonna be mad at you your investors are gonna be like oh why are you bringing this stuff up you need to focus on growth like like i didn't you know like people will give you a hard time to bring this stuff up until it's too late and then everyone's like why didn't you bring this up earlier to play devil's advocate though well we have a bunch of great engineers at dalton we could always get accu-hired right yeah so we have the data here at yc

and i will not tell you that no acquisitions ever happened but similarly what i was saying earlier where if you only read techcrunch about the successful fundraisers it gives you a warped perspective on how common they get are successful and that most series a fundraisers fail well guess what no one gets acquired effectively like there's an asterix next to no one but the the companies of the companies that attempt when they're low on runway they're they're they flew the plane into the side of the the mountain

there's no acquisition coming man like i'm sorry like maybe you could get lucky maybe you built a great team everyone says that but again like to keep picking on the fast thing i think a firm paid them zero dollars i believe to get all of their engineering talent what would the incentive have been for a firm to pay any money for a company that's rapidly dying there's no market for a company that's out of money right anyone that's smart on the buy side knows that a company that is hemorrhaging cash will soon be bankrupt

why would you want to buy that problem you're almost worth less than nothing because you often have legal liability and so no one wants to buy problems and and i think that that's so unfortunate because once again if you're sitting at 12 or 18 months of runway there's even flexibility on the acquisition front that doesn't exist when you're sitting at three to six months of runway like

you can do all all of the moves that you can do to rescue your company require time so let's talk about that let's talk about the moves what are some of the tough decisions that you might have to make if you find yourself default dead and you want to change that let's go through the list of pain uh what's number one nothing well for most folks it's it's it's literally head count it's not office snacks i'm sorry

that's probably not the thing that's you know perks are not bankrupting the company it's that you hire too many folks people are expensive and this is 80 like i've just seen so many people's like burn spreadsheets you know you have two that's always the thing they want to be like well but we're very cheap or we're you know they want to tell a story but it it's it's people over hiring is the thing and i think it's sad because no one likes letting people go no one

let's like like let's go letting good people go right it's it's horrible the best founders if they have to do this will make sure that they get other jobs we'll make sure that they that they're well and the best thing is to never over hire to begin with like like honestly yes actual hack is to not over hire yes once we start having that we over hire now what do we do conversation let's not have that conversation like that's like too far so the actual advice is don't make it a problem and then you don't have to worry about how to fix it

the number two is ad spend and and man we see this all the time it's well we have this top line goal we need to hit 80k mri right michael wait we need to we need to hit 80k mrr we got to hit it and so we got to spend this much money on ads in fact we have to spend more money on ads every month because we're growing to hit our growth going yeah and unfortunately the result of that is also that like our payback period for every customer that

we're acquiring is either super long or long and growing so our ad dollars are getting more ineffective as we are scaling them up and we have to show growth because if we if we stop increasing our ad spend basically if we stop steering the plane into the mountain and putting the gas yeah we're like putting throttle in if we don't do that we won't raise and so you'll talk to founders but they know the problem they're like yeah yeah we're

in trouble we need to raise and we're like well maybe don't like don't crash the plane to the mountain and they're like yeah yeah but you don't get it if we don't put the throttle into the side of the mountain we won't be able to raise and it's like these are the most frightening conversations it's so bad and i think what they and what they don't want to do is take the l like they don't wanna they don't want to take the growth hit because they they the the idea that maybe someone would fund them or maybe they could sell their

company in some long shot scenario prevents them from not steering the company in the map right and i think this isn't talked about enough like many successful companies have had to take l's along the way oh yeah like learning how to take a punch is not a bad thing losing face no one cares no one care oh you reduced your ad spend your growth evaporated but you're around to live to fight for another day that's fine and then the last one and you brought

this up in previous conversations raising prices it's like wow well the thing that we're selling now money this thing we're selling a lot of right now we lose money every time we sell it maybe we could increase prices so that we are break even or we make a dollar every time you sell it oh no that means we're going to sell it to fewer people it's like yes so our plan is to sell a dollar for 99 cents and it's going well and we're like well have you considered

not losing money on every transaction like absolutely not well how dare you even suggest that you talk about this a lot like i think it exercises a different muscle in your customers brain when they know they're getting a deal right it's like like in some weird way they're willing to use a product that's like they would never use in any other circumstance if they know they're getting a dollar worth of value for 75 cents well and you see this in new york recently with uh the 10-minute delivery

stuff there was like eight of them and you could go get free they all had coupons so as a consumer you could like get a lot of free stuff and that was all vc subsidized every time that company is losing money and like everything it's a wealth transfer from investors to consumers yeah i actually appreciate that you know yeah it's and to be clear some of these companies may make it there maybe one or two yes but my guess is the ones that make it are very very very smart about this

stuff i mean yes as per doordash who i guess we always talk about but you know they were good at numbers and they they understood default to live defaulted and they understood burn like very sophisticated and so even though they were pla they were they were flying the plane very close to the mountain yes but they were also very aware of the mountain they knew what they were doing they were test pilots versus hey i don't know like i i read in techcrunch that if the more i burn the more i raise so i guess look do you see the difference folks like doing high

risk things when you're sophisticated and you know the risks is going to work out better for you than wishful thinking high risk takers that never works not racial yes and so what's interesting here is this idea that you know i i was thinking about this taking one of these hits right taking a big hit to your growth rate in order to get to default to live it sounds a lot like bankruptcy it kind of sounds a little bit like personal bankruptcy where it's like you

take a hit on your credit score to kind of clear your debts and the benefit though is you clear your debt like like you you are now living sustainably as opposed to um unsustainably now here's why it's better than bankruptcy i think in a traditional bankruptcy it takes seven years for your credit to kind of get repaired um the startup world works a lot faster than that so at any given time in your startup you're being judged on the last six to 18 months

and so if you take this hit you cut your revenue in half but you get to default to live and the result of that is you get to spend the next six to 18 months building a better product getting closer to product market food or getting product market fit you're going to be judged on just that last six to 18 months you're not going to be judged on when you had a horrible business that was burning more money than it was making structurally and you're gonna have a huge advantage and what's tricky was like this was kind of

our story at justin tv and twitch like almost exactly like yeah you had the choice you looked into the precipice you guys could have jumped in you could have just let it go like right you could have let it go so i mean we had raised about seven or eight million dollars we had grown to about i don't know let's say like 30 million monthly um people were watching content we were making about 750 000 a month in revenue but we were we had a million dollars a month in

expenses we were burning 250 000 a month and i swear to god like to come to jesus moment was with half a million bucks in the bank and i always loved this because like you know as yc founders we don't talk about these mistakes and want to give you the impression that we didn't make them like we made this exactly we were right there they taught me this mckinsey and harvard business like no like you know that's what's nice about being former founders is yeah man we got all this [ __ ] wrong

yes like no one's actually playing right towards the mountain like straight on like like deep deep mountain not top mountain and we i remember we had this meeting um with a lot of our employees and we were like look we got three options we can die in two months we can try to get to break even um or we can try to get this thing profitable and i remember like i had to call this meeting and it was one of the most

embarrassing things i've ever had to do up front because i'm just like talking about admitting defeat i'm like here's the thing we're gonna die i messed up you blew it yeah everybody i'm bad at my job exactly like raising my hand i suck at this hey guys i let us astray yes and i remember thinking and i think this is the silver lining i remember thinking i have no idea whether everyone's just gonna quit

or whether they're gonna rally and everyone rallied and it shocked me but then like i thought about it more and i was like what kind of person joins a [ __ ] startup right it's not the kind of person who's like well i don't see any risk here like this seems like smooth sailing all the way right these are very uh mature um veterans absolutely not right and so you know we selected for the right people on the pirate ship right like the pirate ship they knew they're on a pirate ship um

and i remember everyone was like we are going to get this thing profitable we had to do some bad stuff we definitely had to let go of some people our version of raising prices we had to put ads on everything like we put pre-roll video ads on anything that moved i remember it was we had this we literally had this easel with a big piece of paper on it and i was like on this side we're going to write down everything we can do to cut costs on this side we're going to write down everything we can do to make more money and we're not going to leave this shitty little conference room until

there's a hundred thousand dollars of revenue somehow a profit here and what's crazy is that we had that meeting in august by october we were break even by the end of december we generated 1.2 million dollars in profit and we saved the company and i remember the feeling of not needing vcs anymore and that's because that's not the last time we pitched vcs but just it was the last time that i feel well it wasn't the last time there was a nice little window where for a second we didn't need vcs to

like us in order for our business to be alive and like and what's funny man is that was the moment you were actually tested and you guys like you and your co-founders like that was it in retro in hindsight you guys had a choice and you did you took the l you took the hard hard but now here you are and that was like really smart and we just see so many folks that don't do it they have that it's like sitting there in front of them the hard move and they

don't do it for whatever reason well and what's crazy is the idea for twitch happened after that and like i it makes sense in hindsight why like we were if you're not just freaked out about dying all the time maybe you can apply your brain to like how to make this thing work i think sometimes it's okay to do a startup bankruptcy like sometimes it's okay to take that l get to sustainable and figure [ __ ] out and especially if you've raised like yeah you see people that raise and again like let's keep picking on

fast like they could have just not spent the money no one forced them to seven months in they could have stopped spending the money and they'd still have a ton of money yeah and so there's some amount of like playing along like like there's some amount of like founder choosing making a proactive choice to not course correct because they believe the fundraising to come in and again this is the point of pg's blog post which is don't do that right and sometimes you know this is what happened to my startup and this would have this what happens to the delivery ones is you

have contractual like lease obligations kill people i had deals with the music industry and there's nothing literally nothing i could do about that and that sucked you know and so to the extent you have a startup that doesn't have contractual requirements to burn lots of money like we work or something you know i'd recommend not starting one of those but if you're in one you should be really careful of this stuff yes um well by the way venture dad is similar right like i am like right when you're hurting you got

to start paying more money out and they can very very similar yeah so what's the big takeaway here i think the takeaway is one um before you thrive you have to survive and sometimes you're within you know sometimes you're gonna hit product market fit in the first 18 months of your company sometimes you're not and if you're running your company default to live you're giving yourself enough time to figure out product market fit

and man sometimes you're getting a product market if it's complicated and you're not losing sleep about the macro environment think about how many founders right now are sweating bullets watching the stock market and watching interest rates and i don't blame them right like i'm not saying that's wrong but the default life founders are kind of like eh whereas the ones who know they need to raise soon there's they're work there's they they ask a lot of questions and i get where it's coming from but they seem nervous i think the second big takeaway here is that investors are not going to twist your

arm to burn but you should also be careful to not react to the slightest suggestion that burning more might be okay like unfortunately or fortunately you're in control here and like if someone whispers to you oh maybe you should slam that slam that airplane into the mountain that's not like that doesn't mean that you're not the pilot holding onto the stick and you can control where the airplane's going like they're gonna be fine and you're gonna be fine yeah this is the thing this is what's so weird about

this business is like who has to live with the rest of their lives that that was their startup or that they could have done something different they weren't able to versus the investors like yeah whatever cool and they go you know they don't think about it at all ever again and then maybe the last take away here is that if you if you are in an operationally intensive business you know a lot doordash you better be 10x better than the people around you at knowing your numbers

at steering that plane well yeah the ceo the founders have to be pushing for this not the board not the vps not your cfo founders have to care about this and i'd argue this is one of the dirty little secrets behind amazon they've always known that they were in a low margin business and they've always run their company that way and i'm sure they were so tempted to look at a google or a facebook and say why don't we do those things and like they had to be strong enough to say because we're not in ridiculous

high margin businesses like they are like we're going to play our game anything i missed dalton any other final takeaways i think you got it i mean i think anyone who's anyone out there who's stressed about raising the next round this is just a helpful reminder you should read the blog post you do the math but you don't have to be as stressed out if your default alive it actually completely changes it's like a weight is lifted off your shoulders it's crazy because you don't yeah you're not hoping that some stranger

somewhere is going to bail you out it's a bad feeling but when you're in control you feel you feel much better so i'd recommend it all right great chatting dalton thanks [Music] [Music] you
