Paul Graham, legendary entrepreneur, investor, and founder of the prestigious startup incubator Y Combinator popularized the term default alive by asking his founders whether they were default alive or dead. This basically means whether the business is on track to reach profitability before it runs out of money based on your current expense, growth, and cash in hand,
It is crucial that startups know whether their business is on a growth or dying path. A startup may be on a growth track, though not necessarily so if its runway – the number of months a company can operate its business unhindered before running out of cash – allows it to survive till it starts generating positive cash. This is true for any business, but established businesses have processes and systems in place to keep them updated on the situation. It is the early-stage startups that must be proactively alert to calculate and understand the runway to help them survive or grow their business. A startup that can turn cash-positive before its runway runs out is default alive. Default dead is one that does not have sufficient cash to survive and maintain a healthy growth rate till it turns a profit and becomes self-sufficient.
An unfortunate reality in the startup world is that while founders and CEOs focus on making business decisions and acquiring customers, financial analysis and planning that can help them calculate whether they are dead or alive is relegated to the sideways. This leaves many startups not having an insight into the runway often resulting in negative cash flow and default death. The concept of default alive and default dead was first introduced by entrepreneur, investor, and Y-combinator founder Paul Graham, specifically for start-ups to know their financial state.
So, what exactly is meant by default dead or alive in the startup ecosystem?
What is Default Alive?
To be default alive means that a startup is on a path or predicted to reach profitability based on its current expenses, growth, and resources, without the need for new investment. In other words, it’s an indication that the company is going to start making a profit before it runs out of money or runway.
What is Default Dead?
A startup company is said to be dead when it reaches a stage of not having enough revenues to cover expenses to survive till it starts turning a profit. A start-up that’s default dead is burning its cash without showing any signs of recovery with the current resources. A default dead startup is not going to turn profitable before it runs out of cash and will need further investment to sustain.
Finding out whether default alive or dead
The reason why many startups lose out is that most of them fail to figure out whether they are default alive or dead, especially in the early stages. Only when the startups understand if their company is default alive or dead, founders can think of ways to handle the impact it will have on the business valuation and the way the VCs, investors, creditors, customers, and other stakeholders deal with the company. Many startups become default dead because they did not look at their finances at the right time and it would be too late when they started analyzing them. One reason why founders don’t ask themselves whether they are default alive is that they falsely assume that their business would be able to raise more money easily, which might not turn out to be so.
Not getting to know or getting to know very late that they are default dead is risky making the startup get into a fatal pinch, a stage of default dead + slow growth + no time to fix it. This leaves them in a situation where they’re stuck being default dead giving no room to fix it before the company goes broke. While raising funds for a default live startup is relatively easy, it is not so for the default dead unless it promises tremendous growth prospects and finds an investor who puts growth prospects above profits.
So how do you figure out whether a startup business is a default alive or default dead? This can be gauged through predominately four metrics;
- Current Expenses,
- Current Revenue,
- Current Growth Rate,
- and Cash on Hand.
For example, a startup currently generates a certain amount of revenue per month and grows at 10% per month, with a fixed monthly expense. Based on this growth rate, it will take the company 15 months to reach profitability. However the cash being generated and the cash balance is not sufficient to operate the business for the coming 15 months, the business can be classified as in a default dead state.
What causes Default Dead?
Broadly, it is a simple case of spending more than the revenue, in other words, unsustainable unit economics, resulting in an accumulation of losses and cash deficits. Even when the company starts making profits, the cash deficit will not have been wiped out or it will not have survived till then. Founders who do not have a good understanding of which expenses are inescapable and which can be avoided during each stage of their business are the major contributors who push the company to the state of default. One critical factor that leads to this situation is the uncontrolled hiring, especially after the 1st round of funding, on the assumption that more talent will drive growth by making the product special. This is mostly not true, especially if the product is moderately appealing.
!["default]("http://paci.ai/wp-content/uploads/2022/09/default-dead-1.png")
How can founders handle this?
It’s important to note that default alive and default dead are only estimates, and other factors must also be considered before making further decisions on the fate of the company. Most segments are getting more and more competitive, and just because a company is default alive today, is no guarantee that it will be alive and not be dead tomorrow. Many of the founders of early-stage startups don’t have the sufficient financial expertise to figure out and understand the meaning of these concepts to make informed decisions.
A Little About Paci
PACI’s finance platform helps reduce this pressure off such founders by helping them organize their finances through a single source of truth and provide better data-driven insights, allowing them to focus on growth and building their company. e. PACI provides startups with a single source of truth giving a bird’s eye view of your finances to planning better to prevent the default dead state.
Paci.ai, a unified finance management platform for SMBs, looks forward to tackling the backward-looking nature of accounting with its insights and predictor modules.
The insights module works on the concept of proactive messaging on trends ( Income, expenses, customers, and key notifications providing a small business with actionable insights at the right time.
The predictor module ( Coming soon), leverages historical data to simulate key but day-to-day decision-making on hiring, buying capital equipment, and planning promotions among others.
