Startups are Financial Suicide: Here’s how to balance the risk
Last month, Mike Knapp, CoFounder of Australia’s most high profile startups Shoes of Prey wrote a blog titled ‘Startups are Financial Suicide’.
Read it before continuing…
Are you with you me? Cool, let’s continue.
Mike’s thoughtful and honest reflective piece struck a chord with the startup, and wider business community. It’s a humbling glimpse into the financial reality and ‘trade-offs’ that founders face when investing their sweat and cash into their ventures.
As Cofounder of an accounting and finance firm that works predominantly with other founders of high-growth/early stage ventures — Mike’s points were on point with the financial reality that I see each and every day.
That includes myself.
As an accountant, founder and relatively noob business owner, the question I always ask myself is this.
How do I build a successful financial story outside of my business, but at the same time giving my business every ounce of time and capital it needs to grow and build shareholder value?
Investing your hard earned money into a new business is a high risk asset class. According to Forbes, 80% of businesses fail. We don’t often hear stories of that 80%. Out of sight, out of mind?
My point is that if you are going to invest every single dollar you have into a high risk asset class, that is your business — you need to balance that risk somehow.
And you can be — by being smart about your personal financial situation as well.
I’ve put together this blog to help you frame what it means to be both a founder and owner of your business, and how you can balance this financial risk so you’re protecting yourself.
The Two Financial Hats
Every founder wears two ‘financial hats’. The first is the ‘Owner’ hat. As the owner, you wear the hat of an investor.
The investor considers your startup capital injected just like the shares bought on the stock market or real-estate investments. You want to ensure the capital and time invested in your business will provide you with a financial return in the future.
The second hat you wear as the Founder/CEO is an employee hat. As the CEO, it’s up to you to ensure your company is well managed financially. I.e — your employees get their pay check and you don’t run out of money! As a CEO, you too are an employee of your company. You should get a pay-check just like everyone else working in your business.
These two roles will conflict. As the owner, your motivation is to maximize the financial return from your business. To generate a return on the investment of capital and time you have contributed while building it. The dilemma you will face is the trade-of between taking income now as a CEO versus long-term wealth creation for your role as an investor.
You earn present income from the salary you make as an employee, as well as dividends the business may pay yourself as an investor. Yet, the more present income you draw from the business now, the less capital there is to invest in the business to create long-term value.
On the other hand, drawing the minimal amount of present income leaves more capital to create higher long-term value (if re-invested wisely) — but at the cost to your current standard of living outside of the business.
Entrepreneurs are masochists.
Starting and growing a business requires a level of resilience and tolerance for risk that is not for the faint of heart.
The problem is that we can get caught up in this behaviour where we invest every single dollar into our high growth, high risk business, and neglecting the most important piece of the entire puzzle — paying yourself!
As a founder, the art to financial management is finding a balance that gives you enough present income to support the lifestyle you need, while still providing the business with the funds it needs to fuel healthy growth.
So, what’s a realistic, happy middle ground? I pondered this for a while, and have been testing this methodology with my clients.
It’s about knowing your Minimum Viable Lifestyle.
The Minimum Viable Lifestyle
You may be familiar with the silicon valley term Minimal Viable Product (MVP). This phrase was popularised by startup guru Eric Ries in his legendary book Lean Startup. The MVP thesis is designed around building the cheapest and smallest product possible, with just enough features to satisfy the early customers. The idea is to work within a cost constraint that achieves the most viable outcome.
The MVP principle can be adapted to disciplines outside of the product development and software world. As an accountant, I like to apply it your lifestyle and personal finances. Let’s call it the ‘Minimum Viable Lifestyle’ (MVL).
The idea behind the MVL is to design your lifestyle so that you are living on the lowest viable cost, which still yields the highest impact to satisfaction. The core principle is that you only spend money on things which have a high personal utility.
The process involves an audit of your personal monthly lifestyle expenses, and eliminating the unnecessary or impulse purchases. The monthly result is your MVL.
From a business accounting perspective, figuring out your MVL provides a guide of what minimum monthly salary you should draw before investing any surplus cash back into your business. Remember, we want to make sure that you pay yourself first, so your personal finances don’t suffer.
If you’re drawing over and above this monthly salary and your business can support it, then it’s okay to leave it. Consider this surplus as savings, and invest it outside of your company!
If your current salary is below this MVL, maybe you can use this calculation as a justification to give yourself a bit of a raise.
The added benefit of calculating your MVL salary is that it mentally draws a line in the sand. Rather than taking money from the business as you need it, it helps you to stick to a fixed monthly salary. Surplus profit in the company can be paid as a dividend, not to be pinched when you feel fit.
If you want the step-by-step break down of how to calculate your MVL, just shoot me an email (details below).
Optimism Bias
Entrepreneurs are extremely optimistic.
We tell ourselves that everything is fantastic. We’re solving the world’s problems, having fun, and living in a constant state of purpose, drive, and ambition. But, deep in our heart, we know that this is rarely the case. Operating in this state of irrational optimism is a good thing, even necessary. Because building a business is hard. And a little positivity goes a long way.
I mean let’s face it — most founders start a venture as a bit of “fck you!’’ to the status quo. We are change makers and are often the contrarian . After all, it’s that kind of thinking that helped you raise that first found of funding, right?
The risk is that if we look at life through a rose coloured lens, it can be easy to think the rules don’t apply to us.
Raising money, growing revenue and winning more customers are great vanity metrics to validate what you’re doing.
But don’t dismiss the core principles of wealth creation, like keeping a personal budget, or appreciating the value of compound interest and asset diversification.
If your startup/business fails, that’s ok — you will be wealthier with the experience.
But make sure you walk away with half-full pockets as well.
If you’re interested in a step by step break down of your MVL, shoot me an email >>>
jason@sbo.financial
