Beyond Layoffs

When the economy showed signs of slowing a year ago, startups took steps like cutting out free lunches or scaling back office parties.

With the downturn accelerating, however, venture-backed companies have gotten more aggressive. In the past six months, at least two dozen have laid off employees, from online advertising company AdBrite to photovoltaic cell maker OptiSolar to T-shirt customization website Zazzle (see table). Those that kept staff have found other ways to scale back, such as overhauling benefit plans, renegotiating leases and cutting work hours.

Everything is on the table. These days, with follow-on funding increasingly difficult to secure, startups are finding that no savings is too small—and no cost-cutting idea too audacious—to warrant consideration.

“The mantra is we’re running our pencils down to the nubs, though we haven’t gotten to where we’re printing on two sides of the paper yet,” says Bill Loewenthal, CEO of Kiptronic, a provider of video ad delivery software. The San Francisco company, which raised $5.4 million in venture funding, has shaved expenses by doing everything from changing water cooler suppliers to downsizing its office space. The end result, Loewenthal says, is a reduction of 10% to 20% in operating costs.

Creative burn rate reduction ideas abound among VCs and portfolio company executives. Those who responded to an informal VCJ survey on cost-cutting strategies that don’t involve layoffs offered up suggestions ranging from the nickel-and-dime moves such as ditching the copier to serious six-figure savings generators, such as relocating staff abroad. Following are some of their approaches to cutting costs for salaries, space, supplies and other expenses.

Give stock, not cash

Several venture-backed companies are increasing the stock portion of’ compensation, while in return asking employees to pass up raises or accept reduced pay. Reducing cash salaries also enables startups to stay fully staffed.

“To avoid layoffs, some companies have offered their employees the ability to trade some of their cash compensation for additional stock grants,” says Jeff Karras, a general partner at Levensohn Venture Partners. Karras declined to specify companies, but Kevin Leu, a community relations manager for local business market site MerchantCircle, says his company is among those paying more in stock. The Los Altos, Calif.-based company, which raised $13.5 million from Rustic Canyon Partners, Scale Venture Partners, Steamboat Ventures and others, recently gave stock options as bonuses in lieu of cash incentives.

Relocate some workers

Moving several Indian employees from the United States to an office in India for one year paid off handsomely for one OVP Venture Partners portfolio company, says Gerry Langeler, a managing director at OVP. The company has seen its cost per employee drop from $100,000 a year to about $24,000, which will add up to about $500,000 in savings this year alone, Langeler says.

The mantra is we’re running our pencils down to the nubs, though we haven’t gotten to where we’re printing on two sides of the paper yet.”

Bill Loewenthal

There is another bonus, too. Having the employees move and then come back actually accelerates the Green Card process from five years to three years, Langeler notes.

Cut hours

Another OVP company is offering employees the choice of a 20% salary reduction or taking one day of personal time off per week, though they still work the full week. Law firm Wilson Sonsini Goodrich & Rosati has endorsed this, and the move has reduced labor cost by 20%, Langeler says.

Kiptronic also saved money by cutting hours for administrative staff by about a quarter to 30 hours per week, Loewenthal says.

Pool providers

Scale matters to service providers. By pooling portfolio companies and negotiating bulk discounts, private equity investors have found they can save substantially on everything from health insurance to telecommunications to office supplies. At Irving Place Capital, a middle-market buyout shop, minority- and majority-owned companies take part in pooled discounts, says David Knoch, senior managing director.

Knoch estimates that typical savings range from 10% to 20% for each pooled offering. On the venture side, Safeguard Scientifics offers a legal and marketing services program to the 18 companies in its technology portfolio, says Managing Director Kevin Kemmerer.

Companies typically save $15,000 to $50,000 a month using Safeguard’s legal resources instead of going to an outside law firm, and $10,000 to $30,000 per month by eliminating in-house marketing expenditures, Kemmerer says.

Use high-deductible health plans

Health insurance costs have risen sharply over the past few years, and startups are feeling the pain. As a result, many have explored or instituted health plans that cover medical expenses only after employees pay a preset amount in out-of-pocket expenses.

To avoid layoffs, some companies have offered their employees the ability to trade some of their cash compensation for additional stock grants.

Jeff Karras

Reducing company contributions to health care payments can help cut expenses significantly, says Bart Schachter, managing director at Blueprint Ventures. Done properly, employees may not even see much difference. Kiptronic, for example, switched to a cheaper, higher-deductible plan, but has increased contributions to employee health savings accounts to cover out-of-pocket expenses, Loewenthal says the company. The company still saves money, and employees don’t see much difference in cost, he says.

Renegotiate all contracts

Anyone can save money switching to VoIP. Startups looking to generate really big savings, however, make a practice of renegotiating not one but all of their supplier contracts. OmniGuide, a developer of precision scalpels for laser surgery that is backed by 3i Group, Shasta Ventures and eight other venture firms, has institutionalized the cost-cutting practice with a program launched in the fourth quarter that rewards employees for coming up with actionable money-saving plans. The Cambridge, Mass.-based company reports that it saved nearly $20,000 a year by switching food suppliers, and that it saved even more by finding a new distributor for sterile filters.

Pressure the landlord

Companies used to seek out long-term leases. Now they’re seen as a liability. In 2009, fashionably frugal companies prefer month-to-month leases that allow them to pressure landlords for rent reductions. They’re also squeezing into smaller spaces, or forgoing expansion plans.

For example, an OVP portfolio company “just moved into an attractively priced sublet space, but rather than signing a lease they are month to month,” Langeler says. “They remain on the lookout for even cheaper space as the market heads towards the bottom. While they run the risk of being kicked out of their current space on short notice, in this climate it is unlikely. On the other hand, they stand ready to pounce if some desperate landlord offers a really sweet deal.”

Name a strategic services guru

The job of cutting costs within a firm and across a portfolio may be best accomplished by someone who is given that particular responsibility. Especially for firms with a large number of companies in their portfolios, a “strategic services” point-person makes sense, says Knoch, who serves in that role at Irving Place Capital. His job essentially involves figuring out ways to leverage the portfolio to save money or increase profits. Of course, the idea is to cut costs, not create yet another new position, so firms might be best-advised to tap someone already on the payroll to take on the responsibility.

Cut side projects

This is no time to be experimental. Startups thinking about dabbling in new markets can save serious sums by not pursuing those plans. “You don’t have the cash to test X and test Y; you have to do this one thing and do it really well,” says Steve Reale, a general partner at Levehsohn.

[A portfolio company] just moved into an attractively priced sublet space, but rather than signing a lease they are month to month. While they run the risk of being kicked out of their current space on short notice, in this climate it is unlikely.”

Gerry Langeler

Narrower goals also mean fewer people can be devoted to projects. Spencer Tall, a managing director of Allegis Capital, recalls that one portfolio company didn’t think it had enough people for a particular project. “So we took out two [other projects], and when they sat down again it forced them to prioritize what they were doing,” Tall says.

Buy a competitor

The paradox of finance is that sometimes you have to spend money to save money. And how better to do that than by buying a competitor and creating single, leaner company? Safeguard’s Kemmerer says he believes the firm can drive profitability faster in its portfolio by combining two companies, and he currently spends much of his time investigating acquisition possibilities.

Operate like a broke student

Venture history is replete with examples of wildly successful businesses started by people so broke they’d consider a Happy Meal a big splurge. Today’s under-funded entrepreneurs can also run a startup on almost nothing. Suggested tactics include renting cars from city car share and using shared offices from providers like San Francisco-based Sandbox Suites.

Partners at venture firm DCM advise portfolio companies to take small-but-they-add-up savings steps, such as switching to open source office software and using VoIP provider Skype for phone calls.

Blog search site Technorati has gotten frugal with food, too. Employees used to gather every Friday afternoon for beers and a nice spread of appetizers. Now it’s down to one day a month—and the treat is chips and salsa, says CEO Richard Jalichandra.

Stay put

Travel and conference budgets are taking a particularly severe beating in the current downturn. DCM suggests that portfolio companies use videoconferencing in lieu of travel whenever possible. Levensohn’s Karras says he’s seeing companies cut back substantially on tradeshow expenses and enforcing tighter policies on travel and entertainment.