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How can a young company survive in the valley of death?
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How can a young company survive in the valley of death?

created Forex ClubApril 26 2024

In the earlier text we mentioned the valley of death curve, which graphically represents a difficult period in the life of most start-ups. The statistics are inexorable. According to data Lending Tree & US Small Business Administration About 19% of businesses fail to survive the first year. If we extend this period to 5 years, only half of the companies in the initial cohort will survive. Within 15 years, only 25% of companies will continue operating. There are many reasons why companies fail. However, in today's article we will only deal with the so-called problem crooked valley of death. How should a company prepare for initial difficulties in running a business?

Four types of company development

Companies are created to generate income for their owners. However, for this to be possible, revenue is necessary. Therefore, the company must somehow convince potential customers to take advantage of the product or service offering. However, this requires costs. In the case of services, this includes renting premises, employing employees, implementing the service and conducting advertising. However, producers must provide themselves with raw materials, a place of production, storage and distribution, employ employees and start sales activities. As you can see, there are a lot of "startup" costs. These costs are most often financed from previously collected funds.

When running a business, it is worth asking yourself the following questions:

  • Do you have the right business model?
  • What are your future development plans?

The business model should be checked both logically and financially. In the first case, you need to determine whether the business makes sense. It is worth analyzing how the company wants to:

  • compete in the market,
  • acquire customers,
  • keep customers,
  • create additional ways of monetizing the client.

In the case of a numerical test, it is necessary to estimate the projected revenues and costs. By making an appropriate forecast, you can easily estimate the funds needed to survive a difficult period.

It is also important to determine the growth potential. On the one hand, investors like to hear about the "growth story", but sometimes too much ambition at the beginning can lead to high costs when starting a business. If expectations regarding revenue growth are not met, the company will encounter liquidity problems.

After analyzing the above issues, a short description of the companies is created. Harvard Business Review at work An Entrepreneur's Guide to Surviving the “Death Valley Curve” characterized companies are divided into the so-called:

  • shape-up,
  • stand-up,
  • start-ups,
  • scale-up.

Each of these business models has its advantages and disadvantages - it should be approached in a different way.

Every company must go through these stages – but to varying degrees

In the case of shape-ups, companies have already achieved high levels of sales, but do not have a stable business model. The reason may be that the market is changing dynamically and products have a short life cycle. An example would be new technologies that make a company's current products obsolete. In such a situation, the company must find a new way to function. As a result, it will be necessary to change the service or the final product. It will be possible to reposition the business or disinvest the existing assets. This is one of the worst situations for companies because it requires convincing investors that the company can cope with the change in the market environment and repeat its previous success. However, it is worth remembering that past success does not guarantee future success.

In the case of a stand-up situation, the business model has potential, but the company has not yet reached the appropriate level of development to be profitable. Such companies are usually located at the end of the valley of death.  In such a situation, the company must focus on scaling its operations and ensuring profitability. Scaling should go hand in hand with protecting your business model advantages. Such companies cannot simply waste their potential. Expenditures should be at a reasonable level so as not to lead to too large operational losses.

Start-ups have ambition, but the business model has not yet been created. In such a situation, companies try to create it through trial and error. The flexibility of such organizations allows for quick changes to the service or customer acquisition model. However, the biggest disadvantage is the weakness of finances. The lack of a stable source of income means that such companies must obtain funds from VC funds or, for example, business angels. Only after forging a business model should a startup scale it.

Scale-ups are "mature start-ups", i.e. companies that have already developed a business model and defined their high ambitions, but scaling has not yet been completed. Since the "unit" model is profitable, the company should increase the number of customers in a reasonable way. The most important thing is for CAC to be lower than LTV, then the increase has a business purpose. Scaling can apply to both digital models (e.g. SaaS) and offline models (e.g. franchising). At this stage, the company is encouraged to grow as quickly as possible, but the role of management is to ensure that it does not grow regardless of the costs. This model also requires funds for development, because it often takes many months or even quarters to repay the capital needed to acquire customers.

Many start-up businesses may be in different phases. This means that there is no single solution to getting out of the curved valley of death. For example, in the case of shape-up, the most important thing is to introduce a new product, which is not always necessary in the case of scale-up and stand-up. However, in the case of stand-ups, it is important to improve the profitability of the product, which is not necessary in start-ups and scale-ups.

That's why it's so important for management and investors to work together and strive to quickly exit Death Valley. You should approach each case individually and do not believe in "one solution that fits all companies".

How can a startup avoid the valley of death?

To avoid getting stuck in the valley of death, a start-up must minimize business risk and reassure investors. The following will be helpful in this regard:

  • Saving resources – it is not worth incurring unnecessary costs, so moving to a larger and nicer office can be postponed until later. The same applies to large bonuses for managers and management boards.
  • Focus on PMF (product market fit), i.e. product-market fit. The product or service must meet the needs of customers, which will allow the company to find its place in the market.
  • Building a strong foundation before major financing – it is important that the founder of the start-up is not put against the wall and has to get diluted at a low price. For this reason, he should take care of the foundations. It is important to show investors that "individually" the business model is profitable and capital is needed for further development, not to survive the next quarters. Then it is much easier to find willing investors.
  • Recurrence of revenues – it is easier for investors to invest in a product if they see that the company has a lot of customers who are satisfied with the product and want to continue using it. This gives you a chance to obtain financing, even if the company no longer has funds for further development. Investors like the "growth story". Therefore, it is worth tracking indicators such as CAC, LTV, churn and net retention.

Summation

There is no one way out of the valley of death. It all depends on the market and the stage at which the company is. For start-ups, it is important to focus on improving the business model and, once implemented, start scaling. It is important to plan expenses carefully because the company's resources at this stage are limited and do not yet have a sufficient scale to be self-financing, which would facilitate organic growth. Without controlling costs and ensuring adequate resources for "difficult times", the start-up owner may lose control of the company and become diluted at an extremely unfavorable price. If the plan doesn't work, the startup will likely not survive.

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About the Author
Forex Club
Forex Club is one of the largest and oldest Polish investment portals - forex and trading tools. It is an original project launched in 2008 and a recognizable brand focused on the currency market.
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