Case Study: How Should a Start-Up Cut Its Burn Rate?

by Nitin Nohria, Katie Josephson, Sophia Wronsky, and Elizabeth Rha

Tyler Smith, the founder and CEO of Puck.io, joined the Zoom meeting and greeted Louis Saad, a venture fund partner, his largest investor, and Puck’s lead director. It was four days before the company’s board meeting, and they had a lot to discuss.

Just 18 months earlier Puck’s trajectory had looked fantastic. An enterprise software company, the four-year-old start-up had completed a $100 million funding round at a $2 billion valuation and was on track to achieve $100 million in revenue for the coming year.¹ When its head count reached 500, Tyler took a lease on a large New York office space. The goal was to take the company public in two to three years.

But then tech stocks had started to slide as the Federal Reserve began raising interest rates to fight inflation. IPOs were postponed, and VCs began advising their portfolio companies to cut costs. Louis, who’d founded two successful start-ups and a third that went bankrupt during the Great Recession—precipitating his shift into venture capital—was especially vocal about the need to aggressively reduce expenses and lengthen Puck’s funding runway.

At the board’s urging, Tyler had laid off 20% of Puck’s staff three months before, with the cuts spread across all functions. Now Louis was pushing for a second round of downsizing.

“Thanks for the email,” Tyler said, kicking off the meeting. “I agree that we need to bring our monthly operating expenses down even further. I intend to do that. But I’m worried about morale. I’d like to find another way to cut costs.”

“I get it—I’ve been in your shoes,” Louis replied. “Your team has done a great job of scaling up. I’ve been happy with most of your spending choices over the past year, especially the new office space, even though it’s used less than we’d like. But we don’t know how long it will take for the markets to stabilize, and personnel costs are still more than 70% of your monthly expenses, so you have few other options. You have to eliminate some perks and—I hate to say it—reduce head count again.” ²

Louis was a persuasive presence on the board, and Tyler had embraced his perspective in the past. But Tyler was also proud of Puck’s fun, hardworking, performance-oriented culture. Another round of layoffs might cause the team to lose faith in his leadership.

“People haven’t recovered from the last round of layoffs,” Tyler replied. “We already have too few people doing too much work, and I’m worried about burnout and talent flight. Other tech companies are reducing head count, but tech unemployment overall remains low. Strong performers have lots of options.”

“I’m content to let the full board discuss this on Friday,” Louis said. “But I want to be transparent: I’m going to advocate for more layoffs. In this environment you have to manage burn rate and runway—everything else is secondary. If you don’t, there’s a good chance you’ll need more funding soon,³ which you may have to raise at a flat or lower valuation. It will be tough to get investors to participate if they don’t see decisive action.”

Runway Isn’t Everything

After Louis made his pitch at the board meeting, Tyler asked for a couple of weeks to study the workforce and burn rate numbers and report back. A few days later he met with Simone Ward, Puck’s chief people officer.

“Before we discuss more layoffs, let’s look at where things stand now,” Simone said, tilting her screen toward Tyler. “This is the latest employee engagement survey.” One chart showed that the percentage of employees who “rarely think about looking for a job at another company” had dropped from 57% (well above the average at peer companies) to 42% (below average). Another showed a 10% drop in employees who said, “I see myself working here in two years.”

“When numbers start dropping like this,” Simone said, “they tend to keep falling. We need to fix this.”

“How?” Tyler asked.

“Let’s finish talking about our retention and recruitment problems before we start thinking about solutions,” Simone said. “Take Renee, for example.” Renee Nichols, Puck’s VP of sales, had given notice to take a job at Microsoft, citing concerns about Puck’s stability and the value of her shares.

“The problem is not just that people see stars like her leaving,” Simone said. “It’s been 10 days since we offered Chris Jones the VP of growth role, and we’re still negotiating. He’s not sure he should leave Axis even though we’re offering him a higher salary and a more senior role.”

Tyler had interviewed Chris and been impressed: He was strategic, hardworking, and a great people leader. But Axis offered Chris great benefits, whereas Puck’s health care plan required relatively high out-of-pocket premiums, its 401K match was weak, and its annual bonus plan was less generous. Chris was pushing for even more money and a significant equity grant to compensate.

“That’s a lot of asks when we’re cutting costs,” Tyler said.

Simone spoke evenly: “Chris’s case just illustrates a trend. Even though we’ve done a round of layoffs, we still face critical hiring needs, and we’re getting feedback that our compensation and benefits package aren’t competitive.” ⁴

Tyler frowned. “Is there more?”

“Yes—there’s Alan,” Simone said, referring to their brilliant VP of engineering. Rivals were constantly trying to poach him and his team. “He’s asking for a discretionary fund for selected salary increases, new software tools, and team-building events like their annual ski trip.”

Tyler sighed. “Does he realize we’re trying to cut costs?”

“I know,” Simone said. “But if we say no, chances are he’ll leave, and lots of his team will follow.”

“Okay, let’s try to settle a few of these things,” Tyler said. “First, let’s go with your idea to double down on talent development programs to improve engagement. I want people to know we’re investing in their growth. Second, please try to stretch on Chris Jones’s equity, but let’s build in clear performance milestones and tell him we’re committed to improving our benefits over time. Third, tell Alan he can’t have an exclusive discretionary fund, but we will do a comprehensive review of his top performers’ compensation. And I’ll schedule a one-on-one meeting to get him on board.”

“Got it,” Simone said. “Have you decided what you want to do about a second round of layoffs?”

“Not yet,” he said. “What do you think?”

“It’s a mistake to focus exclusively on runway,” she replied. “You have to balance that with the fact that you need a great team motivated to work here. We lost some goodwill with the first layoffs. A second round will affect our credibility, and it will be tough to convince the team that the future here is bright.”

“I agree,” Tyler said. “But with the board pushing for more cuts, it’s hard to say no.”

Three Cost-Saving Options

Over the following week Tyler noted headlines about the many large and small tech companies⁵ announcing layoffs. Louis continued to argue that laying off 10% of the staff represented an opportunity to part ways with the quiet quitters, poor performers, and employees reluctant to come back to the office. Puck’s new offices were nearly empty most Mondays and Fridays, and some employees weren’t coming in at all.

Simone and Ed Bills, Puck’s chief financial officer, had worked over the weekend to put together a few scenarios for reducing the burn rate. On Monday they asked Tyler to sit down with them, and they laid out three options for him to consider.

“If you see no choice but to do a 10% head count reduction, we should make targeted layoffs, team by team, instead of an across-the-board cut that affects all teams,” Simone said. “We’ll also need to adjust the product road map to reflect the reality that fewer employees will accomplish less.”

Ed pointed to one upside of this plan: Because they’d be saving money on salaries, they could preserve some budget for learning and development, food, travel, and events to maintain morale. Still, Simone warned, doing layoffs twice within a year would have a negative impact—and some star employees might head for the door.

As an alternative to more layoffs, the trio discussed another, two-pronged approach. To reduce head count, Puck could stop replacing departing employees and do more to manage out weak performers. Attrition the previous year among people Puck wasn’t sorry to lose had been low at 9%, Simone explained. But they could let that number move up to 12%. The company could further reduce spending by cutting the budget for events and food, removing low-usage benefits and perks, and pulling back on other areas of spending on contract and vendor services and marketing, which had increased over the past few months. “If we communicate about this the right way, people will understand that we’re making these sacrifices to avoid more layoffs,” Simone said. “I think the damage to the culture and performance will be less than if we put more people out of a job.”

“But remember,” Ed chimed in, “when you cut people costs through attrition, the savings come more slowly and less predictably, and the increased workload for those who stay may lead to burnout, lack of trust, and unwanted departures.” ⁶

Case Study Classroom Notes

In 2020 software-as-a-service start-ups receiving Series D or later VC funding had a median pre-money valuation of $580 ...

He offered a third option: “I love our new office space, but the reality is that it’s nearly empty two days a week. We could move to a remote-first model, sublease the entire office, and ask people to work from home or from lower-cost coworking spaces. I think that could save us roughly $5.5 million to $6.5 million annually.”

“Those cost savings are tempting,” Tyler said, “but I still worry about our culture and collaboration. We made it through the early days of the pandemic, but performance really picked up when we got back to the office.”

Simone nodded. “True. But this could be an opportunity. If we go with this plan, we can invest at least some of what we save in other drivers of employee engagement, like learning and development.”

Tyler thought back to the all-hands meeting where he’d announced the first layoff—a painful memory. If he announced another round of job cuts, putting another group of employees out of work, would he still have credibility as a leader?

He swung by the office to pick up his laptop and then began the walk home. He had a call scheduled with Louis for 8 o’clock the next morning, but he still didn’t know what was best for Puck.

The Experts Respond: What should Tyler do?

Patrick Pettiti is the founder and CEO of Catalant Technologies, a Boston-based software company.

Tyler’s situation is relatable. The tension at Puck among employee engagement, top-line growth, and expenses is real. The challenge for its leaders is finding the right balance, which is especially hard in such an uncertain market. If I were in Tyler’s situation, my number one priority would be to preserve capital while ensuring that my employees had what they needed to be successful.

Unfortunately, the attrition strategy isn’t viable, in my opinion. When you use performance management to drive people out, as Facebook has reportedly begun doing, it looks like a rolling, unannounced layoff, which is worse than a formal one. Good managers and organizations review and rate team members to support and improve their work, not to reduce head count. Puck shouldn’t risk its reputation as an employer by taking that approach.

Layoffs may prove necessary, but if Tyler goes that route, he needs to choose the percentage of head count carefully and then guarantee that the reduction will be the last one. If he’d made a deeper cut in the first round, his lead director might not be pushing for a second one so quickly. Two layoffs in a year is bad; three would be much worse.

Tyler could choose to raise capital instead. Although Puck’s trajectory has slowed, revenue is still growing, so if cash gets really short, he might be able to bring in more money through a flat round. I wouldn’t advise taking a significant amount of additional financing at a lower valuation—a down round; that’s likely to hurt employee engagement too, because it affects the value of employees’ equity.

I would also look seriously at eliminating the office. Many organizations—including ours—have considered that option. We recognize the importance of a place to create community and for people who prefer not to work at home. But the reality is that most desks are empty most days, so this is a large expense that everyone should examine.

Shan-Lyn Ma is a cofounder and the CEO of Zola, an online wedding registry and planning company.

I worry that Tyler is isolated. He’s receiving a lot of information secondhand from the chief people officer about issues in which I’d expect a CEO to be directly involved—for example, in the hiring of a key employee. So I’d advise him to reengage with his top team and make this a collaborative decision.

Puck’s senior leaders should decide what to cut on the basis of their evolving strategy. Their B2B customers will be under budget pressure too; how should that inform the company’s priorities going forward? This approach will help everyone understand that cash is no longer free-flowing. It will get the entire team involved in finding a solution. And Puck’s leaders can present it to the rest of the company as a united front.

Relying on attrition is the riskiest of the options on the table. The company would have no control over who might leave. It would risk losing good people in roles that must be filled while retaining some people who are in noncrucial ones. And the speed of attrition would be unpredictable.

I don’t think Puck should give up the whole office space. It has built a successful culture, and working face-to-face enhances that. Productivity went up when people went back to the office. Puck should consider subleasing excess space or even sharing space with a sublessee on days when its employees don’t come in.

That leaves layoffs, and at this stage I think a second round is absolutely the right move. In fact, I’d tell Tyler to reduce Puck’s head count by significantly more than 10%. A minimum of 20% would be my recommendation. The company’s burn rate relative to revenue is no doubt too high, and most of that expense comes from people costs. Making no change could mean running out of cash in a year with no idea what the funding environment will look like. So Puck needs to extend the runway—quickly.

This dynamic can be seen across the tech industry, not only at start-ups. Facebook, Google, Amazon, and many others expanded head count aggressively over the past few years and now have to pull back. If the world’s most profitable companies are facing layoffs, Tyler and his team shouldn’t feel bad about having to make them too. But communication will be key. The leadership group needs to put policies (such as severance) in place, clearly explain why the cuts are necessary, and then work to motivate, engage, and develop the remaining employees—and keep them excited about Puck’s future.

HBR’s fictionalized case studies present problems faced by leaders in real companies and offer solutions from experts. This one is based on a case prepared by the authors for use in a series of workshops to engage portfolio company CEOs at Thrive Capital.

A version of this article appeared in the July–August 2023 issue of Harvard Business Review.