What Is the Death Valley Curve?
The death valley curve describes the period in the life of a startup in which it has begun operations but has not yet generated revenue. The term, commonly used among venture capitalists (VCs), is derived from the shape of a startup company's cash flow burn when plotted on a graph. During this period, the company depletes the initial equity capital provided by its shareholders.
- The death valley curve is an expression used by VCs to describe the critical initial phase of a startup company.
- During this period, startup companies must operate without any existing revenue, relying on their initial invested capital.
- Surviving the death valley curve means beginning to generate sufficient revenue to become self-sustainable before the initial invested capital runs dry. This is a significant milestone for startup companies.
Understanding the Death Valley Curve
A startup company's death valley curve is the span of time from the moment it receives its initial capital contribution until it finally begins generating revenue. During this window, it can be difficult for firms to raise additional financing since their business model has not yet been proven. As its name implies, the death valley curve is a challenging period for startup companies marked by a heightened risk of failure.
The reason the death valley curve is so challenging for startup companies is that numerous expenses must be borne before a new product or service can begin generating revenue. These include predictable costs, such as renting office space and paying employees, as well as other costs which are harder to predict, such as marketing and research and development (R&D) expenses.
Surviving the death valley curve marks a significant milestone in the life of a startup company, signaling to investors that it has survived its startup phase and stands a better chance of reaching maturity.
Generally speaking, the longer the death valley curve, the more likely it is that the company will fail prematurely. The shape of the death valley curve will vary on a case-by-case basis, depending on factors such as the business plan, the industry niche, and the amount of seed capital invested in the startup.
Unless a startup has shrewdly budgeted for this difficult phase and is prepared to carefully monitor its expenses, it will likely struggle with liquidity issues. The longer the death valley curve persists, the more difficult it can be for a company to invest in growth initiatives and begin scaling its business.
Example of a Death Valley Curve
Suppose you are the founder of a startup company called XYZ Services, which follows a Software-as-a-Service (SaaS) business model. You recently obtained $5 million from initial fundraising, and expect it to take three years before XYZ begins generating revenue. You expect the first two years to be spent developing the SaaS platform and the third year to be dedicated to user-testing the software, with first sales commencing at the end of that year.
Together with your management team, you develop a plan for managing cash flow throughout this critical period. With 20 team members and an average salary of $70,000, you estimate that payroll expenses will total $4.2 million over the period, for an average of $1.4 million per year. Office and administrative expenses, meanwhile, are estimated at $300,000 in total, or $100,000 per year. Altogether, you expect to spend $4.5 million over the first three years, leaving a contingency budget of $500,000.
Considering that you expect your expenses to remain at roughly $1.5 million per year for the foreseeable future, your firm will need to begin generating at least $125,000 in revenue within four months following the end of the three-year startup period. Failure to do so would cause XYZ to burn through its contingency budget and face a cash crunch.
When plotting these figures on a graph, you see the death valley curve that your company must navigate to survive.