Hacker News Reader

Comment by calrueb | Hacker News Reader

With these non-IPO companies doing layoffs is the correct way to read these announcements "we are letting people go to lower expenses because we are not profitable and are actually at risk of running out of money" or is it more "we are letting people go to lower expenses because our investors are asking that we look better on paper because they would like us to have a liquidity exit event (acquisition, private equity, IPO)"?

I suppose my larger question is if a private company is break-even/profitable would the investors/board ever ask management to make these cuts? If so, why?

View on HN

All of the above.

Suppose you have a company with no money, but with a bank willing to loan you money at market rate. You can do three projects, one costs $1 mil, and after a year brings you $1.5 mil in profit, the second costs $1 mil and brings $1.05 mil after a year, and the third costs $1 mil and brings $1.01 mil.

In 2021 interest rates were near zero, so all three projects would have given you a profit. The worst of the bunch only $10,000, but that's still nice. So you hire people to do all of them. But now at the end of 2022 interest rates are about 4% and climbing. The loan for each project now costs $40,000, making the last project unprofitable, and the second project will only be profitable for a couple more months at best. So you cut projects 2 and 3, laying off everyone working on them.

That's how a healthy company would end up with layoffs. A less healthy company might only have projects like the second and third one, and is now running around trying to improve efficiency. And some companies don't make profit at all, being afloat on the hope of eventually making some, and slowly sinking as that money becomes more and more expensive.

Really good summary of how different economic times are handled differently at a business strategy level. It's worth noting as an engineer because risky startups 2 years ago are not carrying the same level of risk for you as an IC to contribute to today. It could be case that a startup closes doors way faster/quicker today whereas a few years back they'd continue burning cash.

This is why jobs are not just a job but you are investing in a company so to speak because if the company is not successful your job may also not be needed any longer.

so you make this assumption that these companies laying off mostly fund their business with short-term bank loans? really?

Lots of mature companies use leverage: if you have a million to spend, you can just ask the bank to give you another two million so you can do three times as much. [1]

If you do have three million sitting around, you still have to consider if you can invest it somewhere else for more money. Why do a low-return project if you get more from investing into bonds?

And of course VCs don't get their money out of thing air, they also have to compete with all other forms of investments for money. So if short term bonds become more attractive while capital is harder to get for potential investors that puts pressure on VCs, who will pass it on.

Of course the actual dynamics are complicated and could fill books. But in the end if you are loaning money you have to do better than the cost of capital, and if you have money your own profit margin still has to outcompete other potential investments.

1: https://en.wikipedia.org/wiki/Capital_structure#Leverage

It's still money and money is like sterile water. If the 0 risk interest rate is 4% and your little project will yield 1%, you are much better parking the money at the bank. Of course, it's a bit more complicated than that; and people like to do projects and build stuff.

But I have seen this in a construction company when interest rates were high (different country, not US). "Big Boss" was always "uncertain" about any new construction work and the bank paid him around 7% to park his money. Come the time when inflation started rising fast (that was 2018, pre-pandemic); and suddenly all that capital was deployed without an after-thought.

So yeah, these interest rates number have real effects.

VC $ works out the same. 18-24mo, with an even higher burn than a bank would accept, and the assumption that you can raise a 2X+ bigger round at the end of it to pay for the previous staff + next round of hires.

VC $ works the same as short-term bank loans? how? in any case, all of this interest rate "math" the parent wrote is only applicable to short-term loans. This is math for a shawarma stand, not a company that raised 300 mil of non-borrowed money.

The interesting difference, and current problem, is VCs expect raised funds to be spent as burn on hiring more people despite existing people already being paid from VC capital instead of revenue. And they expect that to keep happening: each next round will be bigger and cover even bigger payrolls. If the next round doesn't happen, layoffs, and if flat (ex: bc markups are down 3x), dilution & quitting by the best - either way, downward spiral that is hard to return from. The gamble is nothing breaks while this happens -- doubling down the bet.

With interest loans based on revenue, it's fine to stop whenever bc you have revenue for (most of) payroll.

Operationally, that expectation is now worse than interest. In the good times, it was free money for free growth, but with fewer and marked down rounds, a killer. Some founders value efficiency, which avoids this issue, but in the last few years, VC boards certainly were encouraging inefficient growth, meaning bad times for such VC-dependent companies.

aren't these companies continually raising funds to stay in operation, which would mean they would be looking out as far as their next anticipated investment and those rates? Looking up CircleCI in particular on crunchbase it looks like they've raised an investment in all but 2 years of the last decade. Last one was two years ago and presumably they'll need more soon if they aren't profitable.

> anticipated investment and those rates

Sorry, what rates are you talking about? VC investment doesn't have any rates, at least not to the startup.

VC funds are not directly controlled by the federal interest rates but their ability to get _their_ investors to invest in the VC is affected. VC funds tend to get less investment when the return on cash becomes much higher. If the VCs cant get enough funding then they are going to turn around to their investments and either whip them to make more money or start giving worse terms to companies looking to raise another round

A down-round is basically death for a startup.

The easiest way to avoid a down-round is to layoff a big portion of your company, and hope investors believe it won't impact your future revenue.

Unless we get back to ZIRP, pretty much every startup in existence is going to down-round on their next raise.

I don't know about CircleCI specifically, but generally, pre-IPO companies are pushed to reinvest profits in favor of aggressive/continued growth, instead of profit. Most companies intentionally overspend, but now that the investments are drying out, they are changing their posture. So, I would guess it's the former, i.e., letting people go to reduce the risk of running out of money.

At the same time, depending on how the business is doing, some investors might look for exits too instead of plateau or later raising another round. So, it could be both.

There doesn't need to be any external pressure. Companies can and do layoffs even when they're doing well. If a line of business just isn't profitable or they this they can be just as effective with fewer staff or they want to outsource headcount. Happens all the time it just doesn't get headlines.

I suspect it has a lot to do with the rate at which companies can borrow money.

did circleci borrow any money? I know they raised $315mil, and none of the smaller companies I've ever worked for have ever borrowed anything.

Corporate debt is pretty common financing mechanism

Common with tech startups like CircleCI? really?

CircleCI raised like 300M of funding and still has hundreds of employees. Not exactly a startup...

For all companies, public or private, they need to grow their gross margins if they want to survive. The last 5-10 years was inappropriately focused on revenue and headcount growth and the tide has very abruptly shifted.

Reply on news.ycombinator.com