The critical thing most startups seem to forget…
I see headlines all the time talking about people who have either left corporate life or borrowed $500 to successfully build a million dollar business. It’s important to celebrate when you do well because it’s not every day you start something from nothing and turn it into a business that generates over $1m.
But even if you’re bringing in that kind of annual revenue, you’re still at the bottom of a giant mountain (albeit a bit further up), looking up at the proverbial peak and thinking “How am I going to get up there?”. And there’s one thing that so many founders continue to overlook that makes it easy to take a wrong step and fall backwards.
What is a million dollar business?
What does it even mean to create a million dollar business? What does it look like? How is it defined? Does it mean you’re actually making money?
Despite the headline glitz and glamour behind a million dollar figure, there’s a lot more that goes into it. And a lot of this comes back to the basics of business, something that’s often overlooked when the sexiness of starting your own thing makes everything else seem trivial.
For instance, just because you’ve brought a million dollars in, doesn’t mean you haven’t moved the same amount (or more) out. It doesn’t mean you are debt free. It doesn’t mean that next month you will be able to pay the wages.
We’re so used to the clickbait articles talking about how successful someone is to build a company that brings in huge revenues, or how a business raised a massive round from the who’s who. That’s great, but if you don’t have something solid behind all of these headlines, how successful are you?
Finance comes second
For many startups, the financials always seem to come second. The belief seems to be: if you build an incredible viral product, everything else takes care of itself. While getting your product or platform right is critical, so is ensuring your business has enough money to operate.
Because without cash, you don’t have a business. And in today’s world it’s not enough to rely purely on outside sources of funding, even when you have a kick-ass product. I’ve been there with a number of our portfolio companies. Even when everything on the customer and revenue front is going the right way, it doesn’t equate to an easier ride with Angels or VCs.
While I’m not advocating that startups act like more established or traditional businesses, at the end of the day the numbers really do need to add up.
In conversations with founders, it’s often apparent how much of a lack of focus there is on the basics of finance — how does your P&L look? How much runway do you have?
So often I’ve been met with the same answers. Examples include:
“We’re not worried about the burn right now because we need to ramp up development to get our product where it needs to be.”
“We’ve got a solid number of users and are growing fast. We want to go even harder on that growth and we’ll then monetize them later.”
Both have validity. You want to get your product right which makes sense (as with a lack of cash flow, you also don’t have a business if no one wants to buy what you’re selling). And it’s also absolutely right to be growing your users as aggressively as possible.
But how will you pay your team to keep developing your product? And how do you expect to continue servicing all those users who aren’t paying anything and expect the best experience or fastest support when things don’t work? You can’t stay up on Twitter all night answering queries.
This stuff seems basic but it’s amazing how many go into this game thinking they’ll create an awesome product and then everything else will flow from there. That somehow when you’re in the sexy world of startups the fundamental rules of business don’t apply.
Cash flow is like the blood running through your veins
Simple fact is that when you’re building something, you will need some form of capital. You will need an awesome team to help create something special. Those people will want to be paid, unless they are happy to go without cash for the promise of a stake in the company you’re creating together. But in an expensive world, people still need some form of cash, from somewhere, to live.
This graph from a study of Harvard Business School alumni founders perhaps shows how low down on the priority list things like financials sit:
Now I agree with the top priorities there (ability to found a team, leadership and product management) but I find it really interesting that finance comes in second from the bottom. The fact that founders place far less importance on things like cash flow forecasting. Even the terms of VC deals, for that matter.
For the few that strike that critical pot of luck and who are in the right circles, finance won’t be as much of an issue. They’ll secure funding at some outrageous valuation and are in turn enabled to put the wheels in motion to build like crazy.
In his latest series of Masters of Scale, Reid Hoffman talks with Peter Thiel about hyper-growth and the need to separate from your competition altogether. ‘Escape velocity’ as Thiel puts it.
In the conversation, both Thiel and Hoffman talk about how it’s necessary to focus on growing the business so quickly that you don’t need to worry about things like funding. Because all that takes care of itself if you have the right levels of compound growth.
I don’t disagree with that under the right circumstances (luck, network, hard work, timing), however there’s a reason the stats say that something like 90% of all ventures fail. Because if you throw all your eggs in one basket and go for growth, but then even slightly miss it, those funding options won’t be there to save you.
I’ve seen that happen many times. Particularly where companies are growing fast but not fast enough. And as we now live in a world where the tech market is ever more saturated (and controlled by the few) getting that sort of stratospheric growth is increasingly more difficult.
Know where you stand
So a lot of this comes down to knowing where you stand when it comes to your P&L. Knowing and being able to act if things don’t go the way you thought they would. Accurately planning how much runway you have and having multiple scenarios if the growth doesn’t come at the blistering pace you were hoping for.
This scenario planning is very handy when you’re still in the process of defining your company. When the product you have isn’t quite working in the market you intend to serve. This can be a dangerous place to be because quite often, startup teams mis-interpret signs that can falsely lead them to believe they have product-market fit.
And when that happens the first inclination of the founder is to spend. Recruit more developers, throw money at marketing in order to start that process of breaking away from the competition. This is the time to capitalize!
But when the product isn’t yet quite right, this is where things start to go pear-shaped. All of a sudden your bank balance seems to be disappearing at a rate that makes you start biting your nails and sleeping even less than you normally would. You speak with angels and VCs but get the same message: “Come back to us when you have another 50,000 users.”
The future looks increasingly bleak.
You begin to scramble faster, looking at how you can now reduce costs in order to keep the company going. That often means a reduction in headcount. Which means development suffers and marketing takes a back seat. Growth slows further…
Some companies will find ways out of this but more often than not, they run out of money and become one of the 90%.
It happens all the time, it’s just that you’re busy reading the article about how someone who used to work in corporate has just built a million dollar business.
— — — — —
Thanks for reading! Like this article? I’d love it if you had time to give it a clap!
