Five Financial Mistakes That Could Sink Your Startup
As a professional deeply involved with helping startups deal with finance and build sustainable businesses, I often get asked what are the most common financial mistakes that companies make and could have a devastating impact on their businesses. In the list below I have summarized a few and also gave advice on how to avoid them.
1. Not having a budget or a plan for the year
The chances of achieving something meaningful are slim to none if you don’t have a target or a goal to aspire to. And as we know “a goal without a plan is just a wish”. I firmly believe in that, especially when it comes to budgeting and planning. The budget is basically a system of checks and balances that ensures you are focused on meeting the company’s goals and measures your attainment along the way. Not analyzing and planning your business can result in having unrealistic expectations that could adversely impact your company and could drive away potential investors and business partners.
Setting time aside to gather input from different people and functions within the organization and aligning your business plan with your business model, road-map and go-to-market plan can dramatically increase your chances of success. The key questions any budget or business plan needs to answer are:
- How is your business going to make money?
- How is you business going to spend money?
- What are the unit economics of your business model?
- How do you generate cash and what is you burn rate and runway?
- When are you going to be break-even?
- How and when can you achieve your strategic milestones?
2. Poor cash management
Cash management is critical to every company, but it is especially critical to startups that often have a very limited runway to reach their next milestone and start looking for additional funding. History has shown that a significant percentage of companies get their cash burn and runway estimates wrong. This is mainly due to a lack of financial expertise, good planning, and overly optimistic forecasts. A few things that could help proper cash management:
- Have a realistic and regularly updated forecast for your business (revenue, expenses, cash)
- Understand your cash conversion cycle (sometimes billed customer invoices don’t automatically and instantly turn into cash in the bank!)
- When fundraising, aim to secure enough money for at least 12–18 months of runway to reach your next milestone (MVP, product-market fit, X amount of customers/MRR, etc.). If you run out of money before reaching that next milestone, your valuation and overall attractiveness to VCs will likely drop
- Start looking for additional funding early on. Don’t wait until you’ve almost run out of cash. Usually, it takes 3 to 6 months to close a new investment round. To shorten that time-frame and secure a commitment early on, stay engaged with potential investors and keep them updated with your progress and traction
3. Not focusing on profitability early on
Acquiring new customer logos without having a profitable model is not always a good idea. This approach will definitely help you get initial traction and build momentum. However, at some point you need to have a sustainable and profitable business model in place, otherwise, each new customer acquired magnifies your losses and puts you one step closer to bankruptcy.
As a rule of thumb, the proceeds from each new sale you make need to cover the direct costs associated with providing the service/product sold plus a healthy margin on top. One calculation I always make is how many new customers/deals need to be closed to reach break-even or to reach a certain MRR/ARR target. A simple calculation for a subscription business reaching break-even will be dividing the company’s monthly operating expenses by the monthly gross profit that each new customer generates.
There are many other useful ratios and metrics that can be applied and tons of different posts what to use and how to calculate it. My personal favorite, when it comes to subscription businesses, is David Skok’s site that has a very detailed and well-explained section on key metrics such as Customer Acquisition Costs (CAC), Customer Lifetime Value (LTV), etc.
4. Completely ignoring the finance function
The finance function can play a significant role in making your organization data-driven and laying out the foundations for scaling the business. Yet having someone with CFO skills on-board (either as an employee or a part-time consultant) is often not a priority for companies until it is too late. Not setting a good financial framework and practices in the early days can cause a lot of problems down the road. And the more you delay dealing with this, the harder and more expensive it gets to be resolved.
Having a trusted finance person that can go beyond the basic accounting transactions and chasing of invoices and get closely acquainted with the business can be very beneficial. That person’s role stretches across different functions and competences and can help you stay afloat by:
- Laying out the financial framework
- Keeping the books clean and have a well organized and timely reporting
- Keeping everyone (founders, management, partners, investors, etc.) well informed and guided about the health and prospects of the business
- Managing the cap table
- Designing entity structure and inter-company relations (in case you need to have more than one entity)
- Scrutinizing overly-ambitious sales targets
- Designing strategic plans
- Engaging and facilitating fundraising and exit
5. Compliance and regulation
As the famous quote goes “ in this world, nothing can be said to be certain, except death and taxes”. In the context of companies, I would say that failing to adhere to the relevant compliance and regulation can ultimately kill your business.
When we talk about compliance and regulation we often think of public companies or huge enterprises in highly regulated sectors such as energy, healthcare, insurance, banking, etc. However, the compliance and regulations list that applies to small business. In general, should not be underestimated and is ever-growing (tax returns, labor laws, GDPR, just to name a few). In addition, depending on your line of business or industry, you could be subject to specific regulation regardless of your company size.
Relying on legal and tax advisers and investing in compliance always pays off in the long term. On the other hand, not complying can result in hefty penalties and even risking your company is closed.
The bottom line
There are countless financial mistakes and ways to sink your startup. One sure way to mitigate financial risks is to look for professional advice and try to on-board finance experts early on even if engaged on a part-time basis with your company.
Originally published at https://payhawk.io on June 27, 2019.