How my first startup went bankrupt overnight

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My story starts 21 years ago when I graduated with a Physics diploma in my pocket. After scouring the job market for 6 months, I finally landed a job as a junior developer at a software company in The Netherlands. For the next 4 years, I honed my skills and became quite proficient in Microsoft technologies.

I worked at Vision Software & Services, a small startup in the heart of The Netherlands. Coen, the CEO, was a total geek like the rest of us, and I have many happy memories of trying to beat him at Command & Conquer. Which was totally impossible, by the way. The guy was a genius tactician.

It was at Vision that I met my future business partner, Menno. He was the resident Art Director and ran the design department. We became friends over many shared projects. In 1999 we decided to take on the ultimate challenge: we both quit our jobs and started a company of our own. Designstate was born.

Reach for the stars

screen-shot-2017-01-07-at-18-05-29At the time a lot of companies specialized in offering either IT solutions or design work. So if you wanted to have a website built, you’d have to get the design from a design agency, have an IT-company provide hosting and backend programming, and hope you could find someone to slice the design into responsive HTML. Typically the agency would say that’s a tech job, and the IT companies would say no, it’s design work.

Our solution was to put everything under one roof. Menno would head our design department, and I would head our tech team. Our slogan was: we provide you with top-notch design *and* technology. On each project, Menno and I would combine designers and software developers, have them work together and learn each other’s language.

The strategy proved to be wildly successful. Our clients loved having to deal with only a single agency. We basically eliminated all the finger pointing between tech and design teams, which was very common at the time.

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We grew like crazy. From 2000 to 2003 we experienced exponential headcount and revenue growth. At the start of 2003 we were a 12-person team, with a nice office in an upscale town in the heart of NL, and we were looking at a yearly revenue of over €400,000. Our team was working on 3 large multi-year projects, none of which had an explicit end date. Money was coming in by the truckload.

Menno and I were a genius team and we did loads of amazing work. We built a business dashboard that got rolled out at KLM, the Dutch national airline. We developed a high-tech videophone for Dutch Internet millionaire Eckhard Wintzen, and we collaborated with famed marketing guru Jay Curry, to capture his ‘pyramid’ analysis method in a web application.

Blinded by success

screen-shot-2017-01-07-at-18-43-32Everything seemed to be rosy. But we were blinded by our own success, and we didn’t notice the unmanaged risk that had crept into our business model.

We had invested heavily in talent, pulling in tech and design heavyweights. This was at the peak of the IT bubble, so we had to entice our team with company cars, company phones, free gas, expense accounts, and more. Everybody else was doing it, so we had to follow suit to get people in.

Almost all of our revenue came from only 3 sources: the large multi-year mega projects that our entire team was working on. We enticed our clients with competitive prices, but that meant that our income was barely covering our expenses. We were thriving, but not growing a cash reserve to hedge against an economic downturn.

Our accountant warned us that our yearly profit was tiny, and we were basically surfing a knife’s edge. She recommended we reduce headcount or raise prices to boost profit. We refused because raising prices would have killed our competitiveness, and letting people go would disrupt the tight-knit family we had built.

Then terrorists flew their planes into the World Trade center. One of our large accounts sold exclusively to airlines and their sales exec predicted that their revenue would dry up. I remember him telling me: “this is going to change everything”. I shrugged it off. We had come so far, we would survive whatever was coming.

I was wrong.

Surprisingly enough it was another project that triggered our demise. Our videophone project had been hugely successful, with us developing a fully functional prototype. Unfortunately demand for the prototype was much smaller than expected. The company CEO kept ordering more work from us, but with his finances quickly drying up it became clear he would never be able to pay us. Our financial backlog quickly doubled in size, then doubled again.

We needed this project to be able to pay our team, and we had no sales team to quickly find us some new projects. So instead of pulling the plug, we kept negotiating and drafting new payment plans.

The beginning of the end

fuckup-night-slide-7Things came to a head in early 2003. Our backlog had grown to over €50,000 with no resolution in sight. Our accountant predicted that we would go bankrupt in 3 months unless we quickly reduced expenses by letting people go.

We refused to disrupt the team. Instead, we cut everyone’s salary a little, then hired an expensive sales manager to get us new projects. We figured we had a rock-solid team of veterans who could easily be placed in other projects. All we needed was a good salesman to sell our expertise to the world.

Our new salesman asked for a  base salary, performance bonus, and slick company car. We gave it to him, and he got to work. He made lots of encouraging noises over the next few months but did not deliver anything. Three months later we were still in the same situation, but now with an extra sales guy on the payroll.

fuckup-night-slide-8Then things quickly came to a head. The videophone revenue dried up completely. The airline guys announced they were going to do all development in-house from now on, and gave us a deadline to extract our team. With only one project left, we had no way to make the next payroll.

We told the pyramid marketing guys of our predicament, and shared our plan with them: we would let everyone go except a core team, and dedicate ourselves exclusively to the marketing pyramid project.

The marketing guys considered our offer and politely declined.

Now we had zero projects, 1 week til payroll, and 13 employees. We were toast.

The aftermath

fuckup-night-slide-9With €3,000 in the bank and a €25,000 payroll only a few days away, we had run completely out of options. So we filed for bankruptcy. That caused quite a stir because at the time it was virtually unheard of for the company founders to file their own bankruptcy with a positive bank balance. I argued with the judge that pulling the plug before we were deep in the red was a sensible move.

We got assigned a liquidator, who started putting pressure on the videophone CEO to pay out the €50k backlog. Menno and I got sent home.

So there I was, at home, with absolutely nothing to do. After running a business for 5 years that felt very strange. Two days later the phone rang. It was Jay Curry, from the pyramid marketing project.

Jay: “Can you work?”
Me: “Yeah, I think so”
Jay: “Get over here. I want to hire you as my CTO”

This was the guy who had walked away from my ailing company, pushing us firmly over the edge. I had to take a major decision that day. Was I going to hold a grudge?

I took the job. Not holding a grudge has been my rule ever since. You never know where you will be in a couple of years, so don’t burn any bridges and don’t hold any grudges.

Lessons learned

So what did I learn from all this?

Pulling the plug on our company ourselves was hugely empowering. Also seeing our liquidator claw back all the money that was owed us was very nice to see. It proved we were morally in the right all along. And I was unemployed for only 2 days before starting my new CTO job. The quick turnaround really lifted my spirits.

But going through a bankruptcy is hard. You let your people down. You let your business partner down. You identify with your company, and so you feel like a total failure. You start soul-searching.

The fact that everyone around us kept offering us condolences also didn’t help. It made the whole experience feel like a funeral. But I also had a nice experience that lifted my spirits a lot. When I went to meet Jay Curry on that fateful day, to talk about the CTO job, he offered me his hand.

Jay: “Congratulations, son. You’re a man now”

To date, he is the only person who congratulated me with my bankruptcy and spun it as a positive experience. It made a huge impression on me.

So here’s what I have learned.

Don’t grow too quickly. Employee salaries are a massive expense in any company, and my example shows it is very easy to go bankrupt if earnings drop too quickly. Always operate with the absolute minimum team necessary.

Don’t be afraid to fire people. You’re not in the business to build a family. You’re in the business to make a profit, from which all salaries are paid. Frantically hanging on to your team does everyone a disservice.

Don’t add sales as an afterthought. Also don’t turn to sales only when business goes sour. Instead, start out your company with a strong sales plan. Sales should be one of your first hires.

When a customer stops paying, create a contingency plan. Don’t assume that everything will be fine. A delay in payment is a big red flag, and things will almost always get much worse. Cut your losses while you still can.

Always have a backup plan to quickly shrink your workforce. It’s not fun to make this plan, but you’re going to need it when your revenue stream collapses overnight. And it will happen eventually.

Build up a large pile of cash for emergencies. When the unexpected happens, and some or all of your major clients suddenly pull out, it’s nice to have a cash buffer to sustain the company for 3-4 months.

Keep your eye on profit. Don’t ride the razor’s edge like we did, with revenue and expenses almost canceling each other out. You should be making a nice healthy 10-20% profit year on year. Use that money to build a financial buffer.

Recognize when it’s over. Pull the plug yourself. Don’t go deep into debt to try and make a miracle happen.

Don’t hold a grudge. You never know where you will be in a couple of years, and the world is a small place.

And finally….

Going bankrupt is perfectly okay. You are not defined by your company. Your identity consists of much more than just being an entrepreneur. A bankruptcy doesn’t mean you fail at life.

 

This post is an expanded version of a presentation titled ‘Failure Avalanche’ that I gave for Fuckup Night Brussels in 2014. I drew all cartoons myself.


Also published on Medium.