4 Quadrants of Startup Success: Are You Healthy, Survivor, Explorer, or In Danger?

How Founders Can Navigate & Thrive in A New Macro Environment

By David Cahn & Caryn Marooney

With the state of the technology capital markets today, one of the most frequent questions we get from founders is: How should the current macro environment impact our decision making as we grow the company?

The challenge for so many founders today is that much of the prevailing wisdom feels one-size-fits-all. Clearly a company with significant runway and strong product-market fit should react differently than one with only 10 months of cash and no customers. Not all companies are the same, so why does it feel like all the advice is identical?

As investors, board members, and frequent sounding boards for founders, we’re familiar with the common trajectories companies take and the positions they occupy along the way. This point of view has helped us develop the 4 Quadrants of Startup Success, which is a framework to assess how your company is positioned — and what you should do about it.

With the x-axis representing amount of cash and the y-axis representing product-market fit, the 4 Quadrants of Startup Success separates companies into four groups: Healthy, Survivors, Explorers and Danger. Once you know which quadrant your company is in, you can decide what actions to take to build and how to plan for the future.

Understanding Each of The Four Quadrants

HEALTHY

Healthy companies have strong balance sheets and high intrinsic value. They are flush with cash and offer a lot of value to stakeholders and customers. These companies have product market fit and a working go-to-market motion.

Most Healthy companies successfully raised capital in 2020 and 2021 and have significant optionality today — they can keep investing in R&D, and many will be aggressive to consolidate their end-markets. Healthy companies will have the additional advantage of more limited competition: incumbents tend to pull back on R&D during challenging economic times and fewer new competitors will get funded. These companies should continue to launch new products and enter new geographies to grow their businesses.

The main challenge for Healthy companies is efficiency. As capital becomes more expensive and profitability becomes a more important part of the valuation equation, Healthy companies will naturally need to shift their financial focus away from growth at all costs, and toward margins and operating leverage. When capital is cheap, growth is rewarded. When capital becomes more expensive, preserving it becomes more important. Guardrails like a strong financial model will provide early warning signals to help keep a Healthy company on course.

For most Healthy companies, efficiency will primarily be achieved through cultural changes: companies will reward employees for hitting revenue targets rather than hiring targets. Expensive perks will be replaced by a culture of frugality. Performance management, a practice largely delayed in hyper growth phases, will become more important. Companies that make this transition well will position themselves to become leaders in the future. Companies that ignore the changing tides — and continue to burn cash without any focus on margins — may find themselves becoming Survivors.

The second issue facing Healthy companies is the view that the valuation landscape has changed, and that these companies may now be overvalued. This makes hiring exceptional talent harder, as it may take years for these executives and employees to see equity appreciation. Proving business model quality will be critical to attracting these executives. Execution will become more important as these companies prove they can grow into, and well beyond, their latest valuations.

Advice for Healthy Companies

a) Adopt a new metric for success

For Healthy businesses, burn is likely not a problem, at least today. However, to truly control their destinies and avoid becoming Survivors, Healthy businesses will need to find a path to cash flow breakeven and ultimately profitability.

Runway (Cash / Monthly Burn) can be a misleading metric because it does not account for the rate at which expenses are growing. It also does not tell you whether the company is on a path to cash flow breakeven — or if it’s on a trajectory to burn cash forever.

An alternative metric is ARR / Run Rate Operating Expenses. This metric tells you how many times you would need to double your business to achieve breakeven. For example, a company with $8M ARR and $2M in monthly OpEx would need to triple ARR just to get to breakeven (assuming no expense growth). If your company has $1M ARR and $1M of monthly OpEx, you’d need to 12x just to breakeven.

b) Consolidate your market

The best companies will continue to be aggressive through macro uncertainty. They may acquire weaker companies to consolidate their markets. Facing less competition from other venture-funded startups, they may be aggressive to grow sales. They will obsess over providing customers with value and continue to refine their value proposition. Don’t forget that this time can be an opportunity for the best businesses.

SURVIVORS

Survivors are the most interesting breed of startup as they have high intrinsic value and probably have product market fit but are at risk because they lack cash.

Survivors are the companies who may raise flat and down rounds and may put in place hiring freezes or layoffs. They likely will become extremely frugal and may even destroy intrinsic value to stay solvent. Survivors will do whatever it takes to ensure they can achieve their mission as a company.

The good news for Survivors is that many of the best companies have been through this — you are in good company. Amazon and Facebook are two examples of Survivors. Both companies survived the 2001 and 2008 recessions with Amazon losing 95% of its market cap at the bottom of the market in 2001 and Facebook raising a down round in 2008. Both came out stronger and more resilient with durable cultures.

As a Survivor, you have already defied the odds and built something the world needs. Now you need to bring the same amount of rigor, experimentation, and hustle to make sure your vision can blossom and flourish.

The faster you determine you are a Survivor, the more likely you are to make it through this phase and become Healthy. Survivors must take immediate action to cut burn and extend runway. If you are a Survivor, your employees probably already know it. Give them clarity around the company’s plans — and a compelling vision for how your company will emerge from this time as a winner. If you do this, you can empower your team and get on the path back to health.

Remember: Many of the best companies in the world today were Survivors in the past.

Advice for Survivors

a) Raise capital

Survivors may consider raising capital at whatever terms they can as cash will keep the company solvent. Many Survivors will raise capital at flat prices or raise down rounds. Companies are currently extending their last rounds of funding, which is a smart way to increase cash balance immediately.

b) Cut burn

Survivors have no choice but to immediately cut their burn to extend their runway. Often, this means Survivors will reduce their investments in growth. They will freeze hiring (just like many large tech companies have already done) and work to achieve more with less. Survivors will often hire a strong CFO and put in place a three-year plan that ensures continued operations, even in the worst-case scenario. Survivors will go so far as to risk value-destruction for the benefit of continued survival.

c) Develop a path to breakeven

Survivors need a path to breakeven more than any other type of company. Once they reach breakeven, Survivors can control their future. Operating cash flow will start to rebuild cash balances and bring the business back into Healthy mode. Especially given the hard choices Survivor companies are forced to make, getting to profitability is the best way to ensure long-term success. Historically, many companies have successfully crossed this chasm and have built enduring companies as a result.

EXPLORERS

Explorers have a lot of cash but do not yet have product market fit. Many explorers are early Series A type companies that are nimble and looking for product-market fit.

Some Explorers are very well-capitalized today given investor exuberance in 2020 and 2021. This means it’s never been a better time to be an Explorer — most of these companies have more time than in any previous cycle to find product-market fit.

It is critical for Explorers to recognize and weaponize this advantage by staying small, nimble, and preserving their runway. Explorers must relentlessly focus and obsess over customer value, as this is the direct path into the land of the Healthy.

A second advantage for Explorers is that these are the companies for whom hiring may get easier: Explorers can still promise employees massive upside if the business is able to find product-market fit. Ultimately, Explorers need to create a product customers love and are willing to pay for– and this is fully in the control of management to execute on. The talent influx to Explorers is already beginning.

Zombie Warning: If you are an Explorer, beware of burning too much cash (even if you have 3+ years of runway). Explorers who inefficiently burn cash are at risk of becoming Zombies. Zombies are companies with unhealthy financials that can survive on their existing balance sheet for years. Zombies may have money and time, but they are not Healthy and do not yet have product market fit. Even worse, Explorers who burn through all their cash will ultimately become in Danger.

Today’s Explorers could become tomorrow’s leaders.

Advice for Explorers

a) Become lean & flexible

Explorers need to be lean and flexible to iterate their way forward. Many Explorers will have small teams — and even though they can afford to add headcount, they will keep their teams small. Given the existential questions these companies are looking to answer, smalls teams will be better equipped to try new ideas and relentlessly iterate. Explorers need to be nimble and question everything to achieve product-market fit.

b) Keep experimenting

As you start to get early data that your product is working, make sure to keep experimenting. Try to identify weaknesses in your offering. Ask customers for feedback and learn from them how you can do better. Often, you’ll have multiple false starts before you identify the right product. Keep trying new ideas and testing new hypotheses until you have one that’s robust enough to scale. Every company that successfully pivoted (e.g., Slack) was an Explorer that ultimately succeeded in this transition.

c) Conduct a health test

The biggest risk for Explorers is to become Zombies — companies with weak business models that don’t know it yet, because they can continue to draw on large balance sheets to fund their investments. The challenge for Zombies is that you won’t know you are a Zombie until you need to raise capital again — and that might be years away. All Explorers should conductor a health test to stay on the right course:

● If you increase burn, does it lead to increased revenue?

● Would customers be disappointed if your product no longer existed?

● Do have lots of people in G&A functions (e.g., HR, Finance) before you have product market fit?

● Do you have meaningful churn?

● Are you adding more new customers sequentially every quarter than the last?

● Do you have a repeatable process for acquiring and serving customers?

● Do customers spend more each year on your product?

If this is hard or you are still unsure if you are a Zombie, the best metric to look at is Rule of 40. This refers to your Growth Rate + Profit Margin. Companies with Growth + Margin above 40 generally have strong business models. Companies with Growth + Margin of less than 40 may be Zombies with inefficient economics.

If you believe you are a Zombie, consider cutting burn — no matter your cash balance. Get back to a nimble state where you can keep exploring to find product-market fit.

DANGER ZONE

Danger Zone companies have low cash and do not have product market fit. Most of these companies struggled to raise in 2020 and 2021.

Unlike Explorers (who have the luxury of time) and Survivors (who can raise capital, maybe at less attractive terms), Danger Zone companies need to act with urgency.

Advice for the Danger Zone

a) Get to break even

If you can get to a breakeven level, you can become an Explorer and keep iterating to find product-market fit. The challenge for many Danger Zone companies is that without product-market fit, it may be challenging to add revenue, which makes getting to breakeven difficult.

b) Sell if you can

Finding a strategic or financial acquirer may be a good path to achieving your vision and delivering value to customers. Does the company have a competitor for whom the acquisition would be strategic? Does the company have free cash flow to support a private equity acquisition? Is that talent strong enough to support an acquihire?

c) Protect employees

Many companies may wind down. The most important aspect of this process is to protect employees. This means that companies will need to provide severance packages and give employees advanced notice. Many will work to help employees find new jobs. Companies often underestimate how long this takes: once you have less than six months of runway, consider starting to calculate the cost of a wind down.

d) The next chapter

There will be another company, another job, another day. By doing this well, you move on to the next chapter. All the lessons from this one will only make you better and stronger. Remember Steve Jobs and Next?

Advice for Every Company, No Matter the Quadrant

a) Re-evaluate your value proposition and messaging

Now more than ever, you need to answer the question “why should anyone care about us?” Cost cutting for customers was not top of mind a few months ago, but it is now. You need to adjust your sales and value proposition to address this new reality.

Re-evaluate your value proposition to make sure you address what your customers care about the most. Your messaging needs to reflect value, safety and simplicity. (RIBS is a useful Messaging Framework)

b) Establish guardrails

Every company needs guardrails to understand their current financial state and avoid getting overextended. A strong financial plan is a great tool to do this. Look at how much you are burning, not just on a monthly basis, but over the next three years. Understand how much revenue you get for every dollar you spend. For Healthy companies, guardrails are a check against continued aggressive growth. For everyone else, they are a vital lifeline to ensure long-term success.

c) Be rigorous about performance management

The pace of hiring at many startups has been relentless. Growth has been rewarded above all else. Success for many managers meant hitting big hiring targets. As startups confront a new macro environment, changes will need to be implemented across the board. Managers will need to be rewarded for efficiency. Companies who delayed setting up performance management systems will need to establish them.

Most companies in high growth don’t get around to being rigorous with performance management. Not every hire works out and not every person is a top performer. Your best performers know the difference. The best companies in the world attract and retain the best people and manage out the rest. Now is the time to put performance management in place if you haven’t already.

d) Remember culture matters now more than ever

Companies need founders who can lead and inspire in uncertain times. It’s an important time to remind your employees of the broader mission and why you need to exist in the world.

Focus on what you can control. While it’s critical to be clear-eyed, honest and direct about the macro, it’s even more important to empower your team to focus on what they can control, as well. Employees need to be aware and make adjustments, but not be paralyzed or frozen by market circumstances. This is a critical time to focus your teams on execution — focus on the work — to create deadlines and drive deliverables.

Symbolic acts from founders can make a statement and define the temperature of the culture, as well. For example, Mark Zuckerberg wore a tie for a year during 2009. Said Zuckerberg at the time: “After the start of the recession in 2008, I wanted to signal to everyone at Facebook that this was a serious year for us. Great companies thrive by investing more heavily while everyone else is cutting back during a recession. But great companies also make sure they’re financially strong and sustainable. My tie was the symbol of how serious and important a year this was, and I wore it every day to show this.”

e) Consider that hiring may be just as difficult

Healthy companies may hope to have a great pool of candidates at discount prices now that the market is correcting. Not necessarily. Big companies are looking safer and more attractive to the risk adverse candidates. Some big companies are raising salaries. (see recent MSFT salary announcement). With the Zombies hiring and paying competitively, it is unclear if the pool of candidates for the Healthy companies will be that plentiful, nor is it clear that salary expectations will change.

Conclusion: Know Your Quadrant and Take Action

While technology is secular, capital markets are cyclical.

That means that even the best companies must inevitably learn to manage challenging economic times. For every founder, this is a time to step up and distinguish yourself. The best founders are molded in times of crisis.

For Healthy companies, this is an opportunity to demonstrate exceptional execution and consolidate your market. For Explorers and Survivors, the next couple years will be challenging, but the reward will be worthwhile. You will have an opportunity to deliver on your founding mission and shape the lives of users and customers. For companies in the Danger Zone, where no opportunity exists to succeed standalone, expertly navigating this time will have a major impact on ensuring a soft landing for employees and for yourself.

While we cannot control the macro circumstances, we offer a steady hand in partnership and support to all our founders. We will be there right with you through this time.

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David Cahn and Caryn Marooney are General Partners at Coatue. The information contained in this blog should not be considered investment advice from Coatue and Coatue may or may not hold positions in the in the companies referenced in this article.