What Every Startup Employee Should Know About Finance
If you work at a startup, you know that your role is probably bigger than what was in your initial job description. This provides a great opportunity to learn outside of your role — and startup employees should embrace knowing a bit about all the functions that make the company run.
In my role at High Alpha, a venture studio, I provide finance services to the companies we launch until they’re ready to hire a full-time finance leader. I’ve been asked by coworkers if all I do is look at numbers all day, and while my job involves its fair share of spreadsheets, the high-level strategy is much more interesting. In an attempt to demystify finance in a startup, I’ve broken out four areas that every startup employee should know about finance.
1. Forecasting and Budgeting
And why you should turn in your expense report on time
In a startup, plans can change in the blink of an eye; even so, the business still has to have a high-level roadmap, and it’s all managed in the financial plan. This forecast (yes, often an Excel document) shows month-to-month sales goals, hiring plans, and other expenses. Most importantly, based on these plans it predicts when the company will run out of cash (assuming it’s not yet profitable), and when they will need to raise a round of funding.
The finance team should help the company find the right balance of setting high, yet achievable sales goals, and budgeting costs to provide needed resources without burning cash too quickly. The team should continuously keep its finger on how the company is doing relative to plan. To do that, all actual expenses need to be gathered at least monthly to make sure the company is in line with plan, and call out any discrepancies before the company is in trouble. This is why timely expense reports are important — the company can only make informed decisions about future spending if it knows how much it’s spent presently.
As a startup employee, you make the cash come in and go out. Everyone on the team helps to bring in sales, whether directly in a sales or marketing role, or indirectly like in a product role (building the best product makes selling easier). Everyone also seems to have great ideas on how to spend money. But since your startup doesn’t have an endless cash supply, if you have an idea for spending money that’s not in the budget, think about the expense like the finance leader: will this cash investment either a) generate sales to cover the cost or b) is it worth burning cash and raising more funds sooner? Judging this second point is hard, but know that the more cash your company needs to raise from external investors dilutes your potential employee ownership in the company; if you have employee stock options, this means they will be worth less — but more on that later.
2. KPIs (Key Performance Indicators)
Certain numbers and metrics serve as the report card of a startup, and the finance team is often tasked with tracking, analyzing, and benchmarking these metrics. By watching and analyzing these numbers and their trends, we’re able to provide insights to company leaders to facilitate decision-making.
KPIs will vary depending on the industry and stage of your company, but there are a few big buckets of metrics that transcend all startups.
One bucket is cash. Knowing your cash burn, how much your bank account is decreasing each month, is important for obvious reasons — running out of cash is the worst thing that can happen to a startup. Measuring cash efficiency — how much cash you’re burning per dollar of revenue you’re generating — is also important to watch for trends. As an employee you may not know the total cash balance or monthly burn, but know that this is (or should be) top of mind for your company’s leadership.
Revenue & Growth
Another set of KPIs centers around revenue and growth. Venture-backed startups are focused on growing revenue quickly. In the SaaS and subscription world, annual or monthly recurring revenue (ARR or MRR) is the key number to track.
The team should also be evaluating customer satisfaction. In SaaS, we’re looking at customer churn rates, and determining the lifetime value of customers based on how long they stick around.
Investors also care about these KPIs. They’re comparing your company’s cash efficiency, revenue growth rates, and customer churn to other companies in the industry and deciding whether they’ll invest. For this reason, it’s important for company leaders to know what the ideal benchmarks are, and the finance team should help the company set goals and meet these benchmarks through a strong financial plan.
The very generic, big-picture rhythm of a successful venture-funded startup goes something like this: the company starts out with some sort of funding to build an MVP and maybe acquire a few customers. Then it raises a round of funding to hit certain milestones (sales milestones, product milestones, or both). It repeats with fundraising and hitting milestones until it becomes profitable or exits in some way (acquisition, IPO, etc.).
As an employee at a startup, you may not be directly involved in the fundraising process, but knowing the basic process should help you better understand the bigger vision of the company and give you a greater appreciation for the cash the company is spending — because fundraising is hard.
Companies need to start fundraising 6+ months before they need the cash. Pitching and finding the right investors takes time and is exhausting. Once you have investor interest, they will require some sort of diligence process, especially in later-stage companies, looking through the company’s metrics and financials (see previous two sections). Then there’s the legal process of setting the terms of the round and the valuation.
Founders are selling a piece of their company in this process; therefore, they’re looking for the highest price for the smallest portion of the company they can sell. This is why raising the most cash possible isn’t always best; sure, more cash gives the company more runway, but it also gives more of the company away. This is called dilution, and if you have employee equity, it affects you directly. Which leads me to…
4. Equity and Employee Stock Options
Startups often give employees equity in the company — it’s a way to provide compensation without spending more cash up-front, and it helps align incentives. When the company does well and hits goals, it increases the value of the company and increases the value of the employees’ shares.
Understanding the workings of employee stock options and equity is important — you should know the terms around your option agreement, vesting schedule, and exercise price. There are many good articles out there explaining these topics, so I won’t re-invent the wheel here. Instead, I’ll tell you why you should care.
Your stock options represent the opportunity to own shares of the company. What the company is worth, and therefore what your shares are worth, depends on the company’s valuation, which is set and reset each time the company raises an equity round of funding. Hitting goals while being cash efficient leads to good KPIs, which leads to better valuations.
Because your startup isn’t publicly traded, you can’t sell your shares at any time. But if the company is successful, your shares will eventually become liquid, meaning you can turn them into cash. This happens when your company is acquired or goes public. And if it’s valued highly, your shares are worth more, and you get a bigger payout.
At a startup, every employee is a decision maker and is critical to the company’s success. You’re a part of building something — building a product, a culture, and a business. In this environment, it’s easier to learn about roles outside of your own and get a better picture of the full business. Keep asking questions, even if they don’t directly relate to your role. The more of the big picture you understand, the better equipped you’ll be to enable the success of the company in your role.
High Alpha is a venture studio pioneering a new model for entrepreneurship that unites company building and venture capital. To learn more, visit highalpha.com or subscribe to our newsletter.