VC-backed company layoffs: Unfortunately, it's just math
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Let’s say a startup company with $1 million ARR raised $10 million at a $30 million valuation because the multiples in the public markets were 30x revenue. The plan is to grow to a $90 million valuation over 18 months, then raise another round of funding, so they put a hiring plan in place to spend ~$9 million in 18 months to get to $3 million in ARR. And it's all done with the assumption that the revenue multiple is 30x.
Fast forward to the market “correcting” and the multiple on revenue went from 30x to 15x. The same company now has to get to $6 million in revenue to get that same valuation. That is going to take longer, though – at least 36 months, but if they keep spending at the current pace, they will be out of money in 18 months.
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Now, they can either stay the course and endure double the dilution in the next round, or half the cash burn and extend the runway to stay the course. Add the additional uncertainty of being able to raise at the lower next milestone and the board decides that they have to fire – all because the math changed.
If you look at the business of VCs, they’re giving startups an amount of money to get them to another milestone – the next fundraising round. But when the market changes, the milestone gets harder to reach – and in this case, twice as hard.
Where does that leave founders? Most likely stuck between their vision and venture capitalists.
What’s the impact? Founders are burning cash, and that cash is from investors, not revenue and gross margin. So, they’re forced to fire people. They’re old model doesn’t work with the new multiple.
No founder wants to fire a third to half of their staff, but it comes down to misalignment. Founders create misalignment when they take venture capital. This isn’t an anomaly, but instead, the economic reality of taking VC capital. You’re at the whims of the market…and the math.
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