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Cash Management is Key for Startups
The best way to keep one’s investment is to have it in cash. This will give entrepreneurs a funding strategy to minimise the common cash management problems.
By definition ‘cash is king’ means that the best way to keep one’s investment is to have it in cash. This concept is well known and seems obvious. Yet, running out of cash is a routine problem for entrepreneurs running a start-up. Therefore, this post gives entrepreneurs a funding strategy to minimise the common cash management problems that CEOs can face during the early days of a start-up. Managing cash flow is essential to ensuring you keep your business healthy and viable. When it comes down to it, having cash flow is what will ensure your business will survive another day.
Of course a great product, great sales strategy and great team are paramount to driving the success of a start-up. But managing these parts of a business are time consuming and can they detract from another vital task that can be pivotal to a start ups success – raising funds. And in short, raising funds is how a company can get cash, scale the business to grow.
- In short, it is critical that CEOs understand the following:
- Understand when their cash runs out
- Recognise the milestones they need to establish in order to achieve a higher valuation
- Develop a strategy to cash milestones in the right time frame.
When creating a cash management plan, it is important you recognise the time constraints you have and what is required of you to meet your deadlines. Fundamentally, to get cash from investors, they want a business that is not high risk. Unfortunately, risk is not a linear process.
Before putting together, a plan, it is fundamental you understand how start-ups are valued. Once you do this, you will fathom why milestones for your cash flow management is important. Like investments, start-ups are valued based on a calculation of risk and reward. Valuations go up when the level of risk reduces. However, risk in not reduced linearly over time. Risk changes in response to significant increments when particular milestones are met. Milestones could include customer traffic or hiring staff. So why are setting milestones so important? They can be a tool for you to work towards before you hit your ‘cash out date’
By definition, the runway is the period of time it will take for a company to run out of cash based on its available cash balances and cash burn rate. As a start-up, cash management and securing investment is challenging. Yet, as a CEO of a start-up, you can establish a time framework that embodies milestones so you can significantly improve your chance of getting cash from investors, which in turn will bring stability to your business.
Your most important milestone - customer traction
When seeking investment, the best way to demonstrate reduced risk is to show an increase in the number of paying customers. If an entrepreneur has a significant number of customers willing to pay for a product, this tells an investor a company has many positive things such as a compelling product which has product/market fit, a winning monetisation strategy and a team that can execute well on tasks.
- However, this is often difficult for start-ups to achieve in their first round of funding. Therefore, investors will seek out intermediate milestones that will give them evidence that risk is being reduced. Examples of entrepreneurs de-risking their start-up can include:
- You have shipped a beta of a product to customers and they are willing to talk to investors to inform them that they plan to buy the product when it ships.
- Your beta customers have sampled the product and are reporting success.
- Your engagement with customers is high
- Your customers are making repeat purchases and recommending the product to their peers.
Establishing a repeatable and scalable sales model
This milestone greatly increases a startup’s valuation and will attract investors looking to invest in a business that is prime to scale. Once a startup meets this milestone, it is important that specific risks are identified. All start-ups are different, therefore during the early days of a venture, risks differ from business to business.
- Risks could include the following:
- Cash management risk – does the business have enough cash to keep going?
- Product risk – will the product do what it is supposed to do. Will the technology deliver?
- Customer risk – will people buy in to the product?
- Execution risk – will a team deliver what they promise. (A company’s risk could instantly go down if the founder has a proven track record’.
- Monetization risk – a start-up could have great customer traction but may not know how to charge customers (think back to Google and Facebook in the early days).
Mitigating risk quickly to secure investment
Often entrepreneurs need to go about raising funds in a sensitive time frame. There can be quick ways to decrease investor risk and seek a higher valuation. Examples of this include having proof of customer traction or customers with written confirmation they will buy in to a product or service. Another way to mitigate risk would be to have an expert consult with investors to explain the science behind your product and to give their opinion as to how your product will solve a problem.
Cash flow predictions
Once you understand these milestones, you must review and monitor this growth in conjunction to your business’ overall cash mangement position. This includes expenses, outgoings and income. How frequently you monitor your cash flow is dependent on the size of your business. This is vital because it is important to have more money flowing in, rather than out.
To summarise, monitoring cash flow in conjunction with ambitions to scale is made easier when a business sets milestones, acknowledges their runway and the steps they can take to minimise risk. If you need help with cash management & forecasting contact Fullstack for advice.
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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech companies, agencies and entrepreneurs.