The video discusses the concept of "default alive" and "default dead" in startups, which was coined by Paul Graham, a co-founder of Y Combinator. Default alive means that a startup has a high enough growth rate on revenue to become profitable before running out of funds, while default dead means that the startup will not survive without additional funding. The video emphasizes the importance of being honest about a startup's financial situation and not taking future funding for granted. It also highlights the challenges of raising subsequent rounds of funding and the need for founders to plan for a wider range of possibilities. The concept of default alive gives founders more control over their company and increases their leverage when pitching to investors. The video also mentions that investors may not like this advice as it reveals potential misalignment of incentives between founders and investors.

- Founders often focus on certain metrics when pitching to investors, but these may not be the most important metrics for running their business.
- Investors may prioritize metrics that are not aligned with keeping the company alive.
- There is a misalignment of incentives between founders and investors, with founders wanting to grow and investors wanting fast growth or quick exits.
- Founders often mistakenly believe that spending more money will lead to faster product-market fit.
- It is important for founders to do the math and make tough decisions regarding headcount and expenses if they find themselves in a precarious financial situation.

- The main issues discussed in the video are overhiring, overspending on ads, and not raising prices.
- Overhiring is a problem because it leads to layoffs and is expensive.
- Overspending on ads can result in a long payback period and ineffective growth.
- Raising prices may lead to selling to fewer people, but it can also result in sustainable profitability.
- Taking a hit to growth in order to become financially sustainable can be beneficial in the long run.
- The speaker shares a personal experience of facing financial difficulties in their startup and making tough decisions to become profitable.

- The speaker shares their experience of generating $1.2 million in profit, which saved their company and made them feel independent from venture capitalists (VCs).
- They emphasize the importance of making difficult decisions and taking risks in order to achieve sustainability and success.
- The speaker mentions the idea for Twitch came after this experience, highlighting the benefits of not constantly worrying about failure and being able to focus on improving the business.
- They criticize startups that continue to spend money unnecessarily, even when they have raised enough funds.
- The speaker warns about contractual obligations and venture debt that can harm startups.
- The main takeaways are: survival before thriving, being in control of the company's direction, and the importance of understanding and managing the financial aspects of an operationally intensive business.
- The speaker mentions Amazon as an example of a company that has always prioritized running their business with low margins.
- The conversation concludes with a reminder that being "default alive" (self-sustaining) alleviates the stress of relying on external funding and allows for more control over the company's future.

The video discusses the concept of "default alive" and "default dead" in startups, emphasizing the importance of being honest about a startup's financial situation and not relying on future funding. It highlights the challenges of raising subsequent rounds of funding and the need for founders to plan for a wider range of possibilities. The concept of default alive gives founders more control over their company and increases their leverage when pitching to investors. The video also mentions that investors may not like this advice as it reveals potential misalignment of incentives between founders and investors. The main issues discussed include overhiring, overspending on ads, and not raising prices. The speaker shares personal experiences and emphasizes the importance of making tough decisions to achieve sustainability and success. The main takeaways are survival before thriving, being in control of the company's direction, and understanding and managing the financial aspects of the business.

Dalton Caldwell and Michael Seibel discuss Paul Graham's essay "Default Alive or Default Dead." They share strategies to cut your company's burn rate and keep your startup alive to see another day. 

Paul Graham's essay: http://www.paulgraham.com/aord.html
Trevor Blackwell's startup growth calculator: http://growth.tlb.org

Apply to Y Combinator: https://yc.link/DandM-apply
Work at a Startup: https://yc.link/DandM-jobs

Chapters (Powered by https://bit.ly/chapterme-yc) - 
00:00 - Introduction
00:23 - Default alive or default dead
02:14 - The calculator
02:59 - Founder's distraction - Fundraising game
07:32 - Fundraising leverage
09:57 - Math are different
11:29 - Kill or cure
15:37 - The fatal pinch
19:22 - Tough decisions when default dead
19:40 - Headcount
20:46 - Ad Spend
22:50 - Raising prices
25:16 - Personal bankruptcy - Taking a big hit to growth rate
26:28 - Twitch's pirate ship
32:22 - Takeaways
32:27 - Survive to thrive
33:15 - To burn or not burn
34:06 - 10x better if operationally intensive business

#ycombinator #startups #burnrate

I remember we had this meeting with a lot of our employees and we were like, look, we got 3 options.

We can die in 2 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 1 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.

It is excellent, it is short, it is easy to read.

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 1 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 alive, default dead is it forces you to be honest with yourself.

If I don't raise any more money, am I going to die?

And default alive is different than profitable.

Profitable means today I make enough money that I am profitable.

Default alive 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 0.

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 going to have to raise a round before I die.

Either you are default alive or you are not default alive, thus default dead.

It forces you to pin yourself down in your own mind, right?

And what's interesting is that another YC co-founder, Trevor Blackwell, basically made a calculator that allows you to calculate this, because 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 will, right?

What do you think are some of the reasons why founders have a hard time understanding this is important math to do?

Like 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 raise money at Demo Day, the belief that you'll be able to raise more money, it's hard to not take that for granted.

But really, once you've started raising money, you get hooked on it.

And so the idea that maybe you won't be able to raise the next round or that it'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 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 gonna make it.

I think, again, we've both been founders.

I don't think you wanna say this stuff out loud too much.

It makes it sound like you're worried or scared.

And you certainly would not wanna 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 in our team and make them not want to work here?

It's that plus raising the next round is harder.

I think oftentimes founders believe that raising the next round's gonna 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 1 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

We're not saying it's always harder, but, and here's the big but, it's a moving target And there's this thing called the economy.

There's this thing called like investors who are people that are not within your control.

And so what you'll see is Whenever there's like choppy waters, the default dead people that were banking on the next round being easy, die.

And the companies that are default alive, when there's choppy waters, they live.

think it's funny because I like your phrasing.

We can't tell you whether it's gonna be harder or easier to raise your next round.

We can just tell you it's probably gonna be different than the last 1.

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.

The margin of error when you're default alive is huge.

You can go out and try to raise a round and fail and be fine.

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 ones.

There's lots of failed fundraisers, friends.

I think folks that are just reading TechCrunch think that most fundraisers succeed.

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 3 months of runway and you're banking that it's gonna work and you're running this thing super tight, what happens if your fundraise doesn't work is you die.

I think about default to live, default to head 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.

When your default's alive, you're in control of everything, right?

It's a question of agency over the outcome, You know?

Well, and Dalton, we talk so much in the batch about leverage when it comes to fundraising.

And when I think about being default alive, there's multiple levels of leverage.

If you don't need a deal, man, you're gonna pitch better.

Like, when you don't need something, you're way more convincing than when you're begging for something.

And then 2, leverage being the investor knows you don't need them.

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.

Whereas on the flip side, if you run your business default dead, you take 2 average 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 thread this needle on this fundraiser, we're dead.

A good investor can always tell whether the company's pitching them is gonna die.

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

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 seat partners telling white seat founders.

Why do they hate when we say this stuff out loud so much?

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?

We're like telling people how the magic trick is performed.

It's like a faux pas, they don't like it.

Why do they always tell us to shut up when we tell people this?

They always tell, and there's like, 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.

Like, I pat your back, you pat my back, you know.

And it's like, yeah, but man, we gotta put those founders first.

And I think that 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.

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 you know, PG talked about this, right?

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 become Uber or whatever.

And some of them completely explode, like fly the plane into the side of the mountain 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?

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.

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 several boards of companies doing just okay.

Versus if you're a founder and you're choosing between, do you want a 0, literally 0, 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 misaligned 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.

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.

Oh, it's like how, Michael, I hear you're demanding people to raise at high valuations.

Aren't you demanding YCFounders to- I am.

I think this is the tricky bit is that like, deep down inside every founder wants permission to blitzscale.

And that they're special and that they're gonna build the next big 1.

And so if you talk to, you know, half a dozen people and 1 of them is like, yeah, I don't know.

Like that's actually the fly on the wall recording.

I wish you could have a reply on the wall.

It's like, yeah, you know, these numbers, I think you want to get these up.

But I don't know if burn's my biggest concern.

And then the founder hears that and they're like, we're going.

They raised a hundred million and they burned it in 10 months.

You'd have to be working pretty hard on it.

We would certainly need a lot of recruiters.

Yeah, cause like, what else are they spending money on?

Like if it was a hardware company, I'd understand, but there's no inventory.

Like, and it's, I assume they weren't getting offices.

You don't just wake up 1 day with a 10 million a month burn and be like, oh, you know, we're cutting free stacks.

You know, we're, This spending is out of control on these stacks.

So there's another concept in this default, a live 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.

Like 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 fit 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.

I always get the opposite hour when they're down to low runway and they, they're like, we're, we're dead.

We're bleeding out, you know, please, please help.

And it's like, if you would talk to me 6 months earlier, we could have tied a tourniquet around your gaping leg wound and you'd be alive.

What's tricky is that if you find yourself even suspecting you could be in this 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 1 wants to do it because it's too late because it's a buzzkill, man.

Your investors are gonna be like, oh, why are you bringing this stuff up?

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?

Well, we have a bunch of great engineers at Dalton.

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 fundraisers, it gives you a warped perspective on how common they are successful and that most series A fundraisers fail.

But the companies, of the companies that attempt, when they're lower on runway, they flew the plane into the side of the mountain.

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.

You're almost worth less than nothing because you often have legal liability.

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 3 to 6 months of runway.

Like you can do all, all of the moves that you can do to rescue your company require time.

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.

Well, for most folks, it's literally headcount.

That's probably not the thing that's, perks are not bankrupting the company.

It's that you hire too many folks, people are expensive, and this is 80 per- 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 whatever.

You know, they want to tell a story, but it's, it's people overhiring is the thing.

And I think it's sad because no 1 likes letting people go.

No 1 likes like, like let's go letting good people go.

The best founders, if they have to do this, will make sure that they get other jobs, will make sure that they're well

And the best thing is to never overhire to begin with.

Like honestly, the hack, the actual hack is to not overhire.

Because once we start having the 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.

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.

And unfortunately, the result of that is also that 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.

And so you'll talk to founders where they know the problem.

They're like, yeah, yeah, we're in trouble.

If we don't 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 don't want to do is take the L.

Like 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.

No 1 cares, oh you reduced your ad spend, your growth evaporated.

But you're around to live, to fight for another day, that's fine.

And then the last 1, and you brought this up in a previous conversation, is 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 we sell it.

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Save Your Startup During an Economic Downturn