A falling tide...

A rising tide raises all boats.

A falling tide reveals who has been swimming naked.

With thanks to Warren Buffet for the swimming naked metaphor, and for those who have not already noticed the tide falling, look over at the startup world and you will see a bunch of naked swimmers right now. (Of course, GM doesn't look too great either right now.) Being caught naked, to explain the metaphor, is operating without enough cash, leading to cuts, layoffs or even shutting down.

Swimming naked is, however, a fairly standard strategy for entrepreneurial organizations. Usually (in a stable or rising tide), no-one can see you are naked, swimming serenely, well covered by the sea.

When a VC firm invests, we are buying shares in the company. The more money we invest, the more shares we buy, and leave fewer shares in the hands of the founders and management. Since we all want the founders and management to do well if the company does well (alignment of incentives), both sides have an interest in the right balance between too much investment and too little. The general plan is for a startup to take "just the right amount" at each step. As the company grows and progresses, the price per share goes up (reflecting the higher value and valuation of the company), allowing for more money to be invested later without taking so much away from the founders and management. For better or worse, this means that young companies, in particular, have "just enough" money to get them to the next stage, plus a little padding, but often not enough to deal with more than usual turbulence. Hence, it doesn't *look* like anyone is naked in usual times. News flash: the current financial crisis is more than usual turbulence.

Hence, seeing all those naked swimmers (startups without enough cash) is actually a sign that the VC investment model is working ... but it is tuned for usual times, not unusual times. Customers have stopped buying suddenly and completely. Investors have turned pessimistic, making it difficult to get a new round of financing. Banks have stopped lending.

The best startups can survive this by reacting fast enough to conserve their cash and hunker down until customers start buying again. This may mean some cuts, but if you don't need to find new sources of outside funding during this period and are able to stay in business, you will certainly be stronger when the tide starts to turn, and you may well be the leader.

In the non-profit world, things are similar in some ways. Non-profits that to not have endowments (and hence "guaranteed" income underpinning their budget), rely on fundraising from year to year. Operating with a significant proportion of your budget dependent on annual fundraising is as close to swimming naked as I can imagine. This is made doubly hard because donors like to give to a cause that is doing something now ... they are not so interested in helping top up the rainy day fund or build an endowment. Hence non-profits grow with current fundraising from year to year in good times and are more exposed than they would like when a downturn arrives.

And so here is the punch line ... please support your favorite charities ... especially now (before the end of the year) to help them close their books, and then re-up in January to give them a solid foundation for the new year. If you can afford it, this is the time to make larger donations, not smaller ones... and consider donating to the endowment as well.

1 comment:

stefano said...

A lot of nakedness in this post. Wow.

We've often tried to understand the difference between running a lean operation and a starving one. How much cash is enough? When does 'cutting fat' become 'cutting flesh and bone' to use another metaphor?

I was particularly pleased to see you broaden the conversation to include the challenge of managing a not-for-profit. Charitable organizations -- and plenty of public schools, municipalities and states, even -- operate for years providing essential social services while they are starved for cash. How much is enough?

In my opinion the only criteria to determine when we are swimming naked or cutting flesh and bone begins with an assessment of mission and stakeholder expectations including tolerance for risk, growth and longevity. There is an inescapable relationship between performance and risk: by definition, high performance systems tend to be brittle and inflexible. Robust systems, on the other hand, have reserves which are essential to sustain change. Not every organization needs to last 100 years, of course, but how long is enough? What is the difference between managing a public school or a homeless shelter or a bed and breakfast, for example?

As you point out in your post, Richard, stakeholders need to be informed and aligned on these trade-offs. But even when they are, managing organizations by design is still very, very difficult.