Why Cash is King For Start-Ups, and How Not To Run Out.
My mentors were right. Cash is king. I learned the hard way.
Without cash, you don’t have a business. Along with time, cash is your most important asset when you are running a start-up. Without it, you have to lay off staff, stop developing product, face the option of closing your doors and dig deep into personal bank accounts to keep things going. There are ways to minimize your risk of finding yourself in this position. Here is how you can keep your ship from sinking:
(1) Know Your Burn Rate: You need to understand how much cash you are spending daily, weekly and monthly. How quickly are you running out of cash? What variable or fixed costs substantially increase your burn rate and during what months? How can you drive those costs down or postpone full payment into the next month to allow more cash on hand this month? How long is your runway? 6 months? 12 months? Do you have a plan if you run out? Make burn rate projections for the first 12–18 months. Know these figures, and look at your records at least four times per week to pick up on changes and re-estimate capital requirements to keep you afloat.
(2) Always Have A Plan B & C Investor. Verbal commitments from investors are not enough. You need to get the term sheet signed to verify their commitment. You need cash in the bank to know that they are in. Some investors intentionally prolong their investment in you to buy more time and conduct additional due diligence. For start-ups, this can be fatal. You need cash, and you need it now. In your projections, account for the months it might take for your investors to do their diligence and transfer funds. What if you don’t receive X amount of money by Y month? Is it fatal or a small bump in the road? What if they pull out last minute and decide not to invest? Who else do you have in mind that can give you capital? Try your best to approach investors when you are not raising funds. Investors pick up on desperate entrepreneurs who are running low on cash, and this will give them a lot of leverage in negotiating terms that are often unfavorable to you, and that is the optimistic outcome.
(3) Don’t Be Optimistic. It is good to confidently steer the ship, however it can be dangerous to not account for the risks inherent in start-ups and the slowness with which start-ups often take off. What if you don’t achieve those sales figures? How will that affect cash on hand over 3, 6, 12, and 18 months? What if you are unable to drive down manufacturing costs and get tax exceptions that enable you to achieve a $1000 price reduction in per unit costs? In this scenario do you sink or swim? If you are close to running out of cash, whom are you going to raise money from? Have a detailed plan and conservatively put together your sales projections. These projections don’t have to be shared with your investors and the world. This is a tool designed to help you, so be careful not to sugar coat your reality.
(4) Don’t Be In A Rush To Scale: Entrepreneurs want to get to $100 million in sales in the first year. They dream big and want to move fast. Moving and growing too quickly is fatal. Paul Graham is cited as encouraging entrepreneurs to first build a business model that does not scale, and to then find a way to scale. Think of Netflix. Their initial model included delivering movies to homes. They found their way, and so can you. There are also a lot of start-ups that fail because they attempt to scale without making iterations to the product or service. They end up scaling with a flawed product because they are blinded by the desire to get big fast. Entrepreneurs need to nail it then scale it. Growing slowly, especially as a hardware company, can help you keep costs low and have a better relationship with your customers. Don’t be in a rush. Success takes time and tinkering.
I hope these points help you better manage your start-ups finances. What other pointers do you have to help early stage entrepreneurs manage the chaos?