I remember we had this meeting 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 dead.
So this was 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.
And so you should read it.
But let me try to give you my crash course in it.
Here's what he means by default alive, default dead.
As founders, 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?
It's kind of an awkward thing to talk about.
You don't want to bring that up in polite company.
And so the point of default to live default dead is it forces you to be honest with yourself.
If I don't raise any more money, am I going to die?
Or am I going to make it?
And default to live is different than profitable.
Profitable means today I make enough money that I am profitable.
My bank account grows every month.
Default to live 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.
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?
And what's interesting is that another YC Co-Finder, Trevor 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 dead 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 barbershop will understand before a startup founder, right?
It's like, it's so logical.
What do you think are some of the reasons why founders have a hard time
Understand this is important math to do.
What's distracting them from this truth?
I think the context is that if you've raised some money, say you're a YC company, you raised money at 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, yeah.
But really, once you've 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 going to make it.
And so I think it's that, man.
I think, I think, again, we both are 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 on our team and make them not want to work here?
It's that plus raising the next round is harder.
So you kind of get screwed both ways.
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 logically it should be harder, right?
Like mathematically there are fewer series A's than seed rounds and fewer series B's than series A's, 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 a series of mini games and the mini games change and get harder.
I think people weirdly think that this fundraising mini game doesn't change.
And sometimes it's easier when you have a great product and great design.
Sometimes your next round is far easier to be clear.
We're not saying it's always harder.
But, and here's the big but.
And there's this thing called the economy.
There's this thing called 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 choppy waters, the default dead people that we're banking on the next round being easy, die.
And 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 this one.
The margin of error when you're default to live 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
We're only reading about the successful one.
There's lots of failed fundraisers, friends.
Lots and lots and lots and lots of failed fundraisers.
And so I think folks that are just reading TechCrunch think that most fundraisers succeed.
So you're getting a really warped view.
And so again, like bear with me.
If you're to fall to live,
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 going to 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 defaults live default that 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 actually your boss.
When you're defaults alive, you're in control of everything, right?
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 multiple levels of leverage.
One, it's confidence, right?
If you don't need a deal, man, you're gonna pitch better.
That's the way life works.
When you don't need something, you're way more convincing than when you're begging for something.
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 gonna be more competition to invest in your business, and therefore is gonna be 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 leverage hits.
Like when you really think deep down, especially like you said, when you're on low runway, you're like, shit, if I don't threat this needle on this fundraise, we're dead.
a good investor can always tell whether the company's pitching them is gonna die.
Yeah, well, 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 that investors can do.
And 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 is this the thing that so many investors don't like us as white seed partners telling white seed 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.
Yeah, it's like a magic trick.
We're like telling people how the magic trick is performed.
Why do they always tell us to shut up when we tell people this?
They always, 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.
You pat my back, you know, we're all this together.
And it's like, yeah, man, we got to put those founders first.
And I think they're 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 oftentimes you're talking about your headcount, your hiring plan, slash the execs you've brought on, so on and so forth.
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 have a point of view that might be not oriented around keeping the company alive.
And PG talked about this, right?
What was PG's line on this stuff?
He calls this in a 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 fasts 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?
And board seats, you're limited as a VC on how many boards you can sit on.
And so you don't want to sit.
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 you look bad to your colleagues.
Like there's all these dynamics that founders are not aware of.
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
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 that to a VC doesn't matter at all.
Like, man, that sure sounds like misline incentives, right, Michael?
Sometimes the investor in this equation is kind of is perceived by founders who haven't raised money yet as like demanding that the company grows.
or demanding that the company burns a lot of money, as if they were the boss.
And I think this is a very bad misconception.
I think that's extremely rare for an investor to be demanding you to burn like crazy.
I think that the horrible truth is that founders don't need much of a push.
Well, it's like, it's like how Michael, I hear you're demanding people to raise at high valuations.
Aren't you demanding why he found you?
I'm twisting their arms to dilute less.
I think this is a tricky bit is that like, deep down inside, every founder wants permission to blitz scale.
and that they're special and that 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.
Maybe burns on our biggest concern.
Like that's actually the fly on the wall recording.
I wish you could have a fly on the wall.
It's like, yeah, you know.
These numbers, I think you want to get these up.
I don't know if burns my biggest concern.
And then the founder hears that and they're like, we're going.
They raised 100 million and they burned it in 10 months.
They got to do a 10 million a month burn.
I'm actually super impressed.
You'd have to be working pretty hard on it.
We would certainly need a lot of recruiters.
We'd have to hire a lot of people.
Yeah, because when else are they spending money on it?
If it was a hardware company, I'd understand.
But there's no inventory.
I assume they weren't getting offices.
It was during COVID, right?
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 you're like oh you know we're cutting free stacks.
This spending is out of control these stacks we need to feel we tighten our belts friends.
So there's another concept in this defaults alive default dead article that was linked to it was another pgsa called the fatal pinch.
I think it's so interesting because we see this in office hours so frequently.
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 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 to happen faster.
And what's sad is that like probably at least for me, more than 50% of the time,
I don't get the office hour before the founders decide to ratchet up the spend.
It's always when it's too late.
I always get the office hour when they're down to low runway and they're like, we're dead.
And it's like, if you had talked to me six months earlier, we could have tied a tourniquet around your gaping leg wound and you'd be alive.
How we could have saved the leg?
What's tricky is that if you find yourself even suspecting you could be in the 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 going to be mad at you.
Your investors are going to 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 good engineers at Dalton.
We can always get accu-hired, right?
So we have the data here at YC, and I will not tell you that no acquisitions ever happen.
But similarly, what I was saying earlier, where if you only read TechCrunch about the successful fund raises, it gives you a warped perspective on how common they are successful and that most series A fund raises fail.
No one gets acquired effectively.
Like there's an asterisk next to no one.
But the companies of the companies that attempt when they're low on runway, they flew the plane into the side of the mountain.
There's no acquisition coming, man.
Like maybe you could get lucky.
Maybe you built a great team.
But again, like to keep picking on the fast thing, I think a firm
paid them $0, 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 I think that that's so unfortunate because once again, if you're sitting at 12 or 18 months of runway, there is 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 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.
What's number one, nothing?
Well, for most folks, it's literally headcount.
That's probably not the thing that's, you know, perks are not bankrupting the company.
It's that you hire too many folks.
And this is 80, like I've just seen so many people's like burn.
Spreadsheets you know you have to that's always the thing they want to be like well, but we're very cheap or wherever you know they want to Tell a story, but 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 looks like like let's go letting good people go right it's it's horrible and
The best founders, if they have to do this, will make sure that they get other jobs, will make sure that they're well trained.
And the best thing is to never over hire to begin with.
Honestly, the hack, the actual hack is to not over hire.
Because once we start having that we over hire now, what do we do conversation?
Let's not have that conversation.
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 man, we see this all the time.
It's, well, we have this top line goal we need to hit.
And so we gotta spend this much money on ads.
In fact, we have to spend more money on ads every month because we're growing because to hit our growth goals.
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 stop increasing our ad spend, basically if we stop steering the plane into the mountain and putting the gas, we're like putting throttle in.
If we don't do that, we won't raise.
And so you'll talk to founders where 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 in the mountain.
And they're like, yeah, yeah, but you don't get it.
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.
And I think what they, and what they don't want to do is take the L. Like they don't want to, they don't want to,
take the growth hit because 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 mouth, right?
And I think this isn't talked about enough.
Like many successful companies have had to take L's along the way.
Like learning how to take a punch is not a bad thing.
Oh, you reduced your ad spend.
But you're around to live, to fight for another day.
And then the last one, and you brought this up in the 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 gonna sell it to fewer people.
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?
And they're like, absolutely not.
How dare you even suggest that?
You talk about this a lot.
I think it exercises a different muscle in your customer's brain when they know they're getting a deal.
In some weird way, they're willing to use a product that 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 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.
It's a wealth transfer from investors to consumers.
I actually appreciate that.
Some of these companies may make it.
But my guess is the ones that make it are very, very, very smart about this stuff.
I mean, as per Dordash, who I guess we always talk about, but you know, they were good at numbers and they understood default to live defaulted and they understood burn, like very sophisticated.
And so even though they were playing, they were, they were flying the plane very close to the mountain.
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.
I read in TechCrunch that the more I burn, the more I raise.
Do you see the difference, folks?
Doing high-risk things when you're sophisticated and you know the risks is going to work out better for you.
than wishful thinking in high risk takers.
And so what's interesting here is this idea that, you know, I was thinking about this, taking one of these hits, right, taking a big hit to growth rate in order to get to default alive.
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 you are now living sustainably, as opposed to 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.
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 alive.
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 fit 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 going to have a huge advantage.
And what's tricky was like this was kind of our story at JustinTV and Twitch.
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 could 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 had a million dollars a month in expenses.
We're burning $250,000 a month.
And I swear to God, the come to Jesus moment was with half a million bucks in the bank.
And I always love this cause 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 exact, like we were right there.
That's what you love about investors is they're like, Oh, I know everything.
And they taught me this McKinsey and Harvard vision.
Like, no, like, no, that's what's nice about being former founders is, yeah, man, we got all this shit wrong.
Playing right towards the mountain, like straight on like, like deep, deep mountain, not top mountain.
And I remember we had this meeting 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.
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.
Cause I'm just like talking about admitting defeat.
Here's the thing, we're gonna die.
We messed up, we blew it.
Exactly, like raising my hand.
Hey guys, I let us astray.
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 fucking 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 mature veterans.
And so, you know, we selected for the right people on the pirate ship, right?
Like the pirate ship, they knew they were on a pirate ship.
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 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 rake more money.
And we're not going to leave this shitty little conference room until there's $100,000 of revenue somehow of profit here.
And what's crazy is that we had that meeting in August.
By October, we were breakeven.
By the end of December, we generated $1.2 million in profit.
And we saved the company.
And I remember the feeling of not needing VCs anymore.
And let's be clear, 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 what's funny, man, is that was the moment you were actually tested.
And you guys, like you and your co-founder, that was it.
In hindsight, you guys had a choice and you took the L, you took the hard one.
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 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 out, get to sustainable, and figure shit out.
And especially if you've raised.
like 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 still have a ton of money yeah and so there's some amount of like
playing along, like there's some amount of like founder choosing, making a proactive choice to not course correct because they believe the fundraiser is gonna 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 at my startup and this is what happens to the delivery ones is you have contractual, like lease obligations kill people.
I had deals with the music industry and there was 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 recommend not starting one of those but if you're in one you should be really careful of this stuff.
Well, by the way, venture debt is similar.
Like right when you're hurting, you got to start paying more money out.
And they can very similar.
So what's the big takeaway here?
I think the takeaway is one.
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.
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 gonna get 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 defaults of life founders are kind of like, eh, whereas the ones who know they need to raise soon, 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 airplanes go.
And they're going to be fine.
And they're going to be fine.
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 investor is like yeah whatever cool and they go you know they don't think about it at all ever again.
And then maybe the last takeaway here is that if you if you are in an operationally intensive business you know a la 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 VP's, 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 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.
If your default's alive, it actually completely changes.
It's like a weight is lifted off your shoulders.
Because you don't, you're not hoping that some stranger somewhere is gonna bail you out.
But when you're in control, you feel much better.