The Dip

Why do the most interesting bits of startup stories always get airbrushed out?

History isn’t fact. It’s narrative.

When a startup is a big success it’s really easy to focus on the end point, and forget about the route. When the stories are re-told over and over, details get re-written or forgotten. And the bits that are omitted and updated are nearly always the stumbles or backwards steps.1 As a result others starting out on their own venture never hear about these hard moments, and so don’t always anticipate that it might happen to them too. The biggest deceit is thinking that it won’t.

One of the few things Trade Me, Xero, Vend and Timely all have in common is that they all had significant near-death moments…

2001: Trade Me

Trade Me was only two years old and still quite fragile. In just 18 months we had grown to over 100,000 members. That was exhilarating. But the original business model (free online classifieds, supported by advertising) had failed to generate any significant revenue.

The original Trade Me billboard: Only Turkeys pay for Classifieds, 2000
The original Trade Me billboard: Only Turkeys pay for Classifieds, 2000

We’d spent all the cash that had been invested. Nobody was interested in giving us any more. The company was being propped up by loans from existing shareholders.

I had only recently become a shareholder myself. I didn’t have any cash to lend, but I did work for several months at a significantly reduced salary, before that became unsustainable. I finally left and moved overseas. If I’m honest, I didn’t expect there would be anything to come back to at that point.

Actually, three out of four from the original team all left, including the founder Sam Morgan and his sister Jessi, who was the first employee before me. At one point, all three of us were living and working as contractors in London, leaving my old friend Nigel Stanford running things more-or-less by himself back in New Zealand. That period of time has never been properly documented, perhaps because it doesn’t fit the preferred narrative of constant growth and success.

One of the last changes we made to the website before leaving was to implement success fees, charging sellers a small amount on each sale. It wasn’t so much that we realised this was the golden ticket - more that we’d run out of any other options, so had nothing to lose. Eventually this would fuel an amazing business model.

Sam, Jessi and I all returned to executive roles in the business within a few years. In 2006 the company was sold to Fairfax for $750m.

That outcome wasn’t obvious at the time.

2008/2009: Xero

Some people, especially Australians, think that the Xero story started around the time of the listing on the ASX at the end of 2012. The share price then was A$4.65, and by early 2014 it had jumped to over A$45.

But there is a long pre-history prior to those glory days, where the market performance wasn’t nearly as good and the outcome for the company was much more uncertain.

I invested and joined the team just prior to the initial public offering (IPO) on the NZX in 2007. That valued the company at $50m, and raised $15m of new capital at $1 per share. For several years after that the share price was below the listing price. Despite the stated global ambitions, there was pretty modest customer traction, more-or-less entirely in New Zealand.

The IPO prospectus forecast that the company would have 1,300 subscribers by May 2008.2 The actual result we achieved was 1,408. Although as this graph from the first Annual Report shows, a good percentage of those new customers signed up in the final few weeks.

Graph from Xero Annual Report, May 2008
Graph from Xero Annual Report, May 2008

The total subscription revenue for that first year was just $134,000. The company made more money from interest paid on the unspent IPO funds. It was an anxious time!

We were burning through cash quickly. It wasn’t obvious that the market would be patient long enough. One analyst speculated that it could be the first public company to be named after its share price.3 There was a high turnover of senior staff during this time, especially sales and marketing related roles. I was one of those who left. Thankfully, I didn’t table flip completely and sell my shares.

In 2009 the company raised NZ$23m of new capital from MYOB founder Craig Winkler.4 MYOB was the incumbent that Xero was hoping to disrupt in both New Zealand and Australia. Craig had only quit as CEO a year prior to that after MYOB shareholders had blocked his share option grant.5 It’s mostly forgotten now but his purchase price was 90c/share (i.e. 10% below the IPO price from two years earlier) and after that investment he owned 24% of Xero.

Around the same time the focus shifted to selling to accountants rather than direct to small businesses. With the benefit of hindsight, that was a turning point. Within the next three years Xero raised a further $170 million of capital from various investors, the number of subscribers increased from 6,000 to 78,000 and revenue increased 20x. Now it has millions of subscribers, is valued at over A$10 billion, and hasn’t looked back.

That outcome wasn’t obvious at the time.

2015: Vend

I was one of the original investors in Vend in 2010. In the crazy five years that followed we had raised over $35 million of capital from international venture funds. We were growing at an eye-watering pace, but also still burning significant amounts of cash. By the end of 2015 we came very close to shutting the company down.

We had signed a term sheet with a new investor who then changed their mind at the very last minute. This left us with some hard decisions to make and no time left to make them. We were spending much more than we earned, so we were “default dead”.6 We had chosen a growth path that required us to get permission to continue to exist from investors every 12-18 months, and time had suddenly run out.

When this all unfolded I was in Berlin, with fellow director Barry Brott from Square Peg, our largest investor. Instead of meeting the new team members we had recently hired, we spent the day informing them that we would need to close the office.

We spent that night on a series of urgent phone calls with existing shareholders, trying to raise further funding. Not surprisingly, there were a range of reactions. I got some very direct and not very complementary or constructive feedback on my performance as Chairman of the Board from some of them. Finding consensus in that environment was tricky.

By the time we finished speaking to everybody it was the early hours of the morning. We decided to head out for some food, and got flashed by a drunk German teenager in the elevator. I was too exhausted to do anything other than laugh at him. I don’t think that was the reaction he was expecting.

I flew from Berlin to Auckland where there were a number of further difficult decisions waiting. We had to urgently reduce the team size, and make a number of people redundant, including some who had worked in the business for a long time and done the hard yards. That was painful.

However, the remaining team found a more sustainable path forwards and we confirmed new funding from existing shareholders. Within a few months there was almost an entirely new executive team and board (Barry was the only survivor) but the business continued.

In 2021 Vend was acquired by Lightspeed, one of our fiercest competitors from back then, for $485m.

That outcome wasn’t obvious at the time.

2020: Timely

Timely was nearly one of the first startups to fall victim to the COVID-19 pandemic. As the virus started to spread around the world, in early 2020, the vast majority of our customers (hairdressers, beauty salons, spas etc) were suddenly shut. We saw our customers forward bookings evaporate as the world went into isolation. We kept a close eye on the impact on our subscription revenue, and it wasn’t pretty. We had no idea how much longer this would continue, but the graph trended pretty quickly to zero.

Rather than hide from that fact, we shared it publicly. I know many people in the sector found that incredibly useful as they worked on their own response. We did the same thing internally. We shared metrics with the whole team showing the revenue impact and the level we needed to stay above. Giving everybody the information they needed to make good decisions was key.

We had to immediately bury our old plans. That required remarkable leadership. Co-founder and CEO Ryan Baker, who with his executives had spent the last few years building an awesome team, committed to preserving every job. We offered generous discounts to customers. We immediately cut board fees to zero and made deep cuts to executive salaries, and then asked the rest of the team what they could do to help. He described the approach to everybody: 7

All of us will be affected a little so that none of us has to be affected a lot.

Overall we reduced the already lean cost base by 20%. Some staff agreed to bigger cuts so that others, who would be more heavily impacted, didn’t have to. It was an amazing collective response.

This created a positive feedback loop. With job security, the whole team focussed on helping customers navigate the lock downs, providing whatever support we could. We retained the bulk of our customer base, albeit on reduced subscriptions. Because many competitors were missing-in-action during this time we even gained market share. That additional revenue allowed us to keep the cycle going.

Remarkably within a few months we were able to repay staff the salaries that had been cut. And shortly after that we started the conversations that would eventually lead to the sale to EverCommerce (one of the terms of that sale was that the wage subsidy we’d received from the New Zealand government was also repaid, which was a nice full stop to this phase).

That outcome wasn’t obvious at the time either!

Hold on tight

These dips cause whiplash for founders. A startup condenses intense experiences and changes people. I have some very negative personal mental scar tissue from each of those stories. Amazingly, they all had happy endings.

These dips are the moments of truth for investors too. It’s easy to support a successful company. When things go badly it separates people who are really helpful from those who are just along for the ride. Normally these are expensive lessons for investors who are prepared to step up in the short term. But also the most rewarding, in both senses of that word, when it works out.

It doesn’t always.

  1. This was really highlighted to me when I watched The Social Network movie about the early stages of Facebook. In one scene they are a small team struggling away in a house in Palo Alto, and nobody has heard of them. Then, it jumps quickly to them moving into their first office and celebrating 1 million users. As if that just happened while they weren’t looking! I couldn’t help but feel like they just skipped over all of the most interesting bits in the story, in a montage↩︎

  2. Xero Live Limited - Share Offer Investment Prospectus, 2007

    The prospectus also estimated that the average revenue per subscriber (APRU) would be $75 (it’s been consistently between $25 and $30 ever since), and contained this wonderful underestimate of the breakeven point:

    Dependent on pricing, the Directors assess, based on their current estimates of Xero’s cost base, that Xero’s New Zealand revenue will begin to exceed its New Zealand cost base at around 8,000 customers. However, Xero will also be investing in the development and growth of the business and pursuing expansion of the business into the UK and Australia. Therefore, the Directors do not currently expect that Xero will record an overall profit for at least three years.

  3. Xero (XRO.NZ) – Thoughts on Valuation, Clare Capital, 3rd October, 2013. ↩︎

  4. MYOB founder buys into rival, Sydney Morning Herald, 7th April, 2009. ↩︎

  5. MYOB shareholders vote down options allocation, Sydney Morning Herald, 25th April, 2008. ↩︎

  6. Default Alive or Default Dead?, by Paul Graham. ↩︎

  7. Ryan Baker, Twitter, July 2020. ↩︎

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