In this series of Being a CEO of a Startup, we look at some of the financial aspects of a business, from funding to cash flow to pricing
The role of CEO / founder in a startup is probably one of the most diverse jobs it is possible to have. But the diversity is also the reward as you see your whole business grow and appreciate what went into that success. In this series I will consider some of the things I have learned over 35 years in and around startups and share some advice for new CEOs.
This month, we look at some of the financial aspects of a business, from funding to cash flow to pricing.
Cash flow is more important than your mother! I’ll say it again; CASH FLOW IS MORE IMPORTANT THAN YOUR MOTHER. Ken Morse, former MD of the MIT Entrepreneurship Center made this statement to ram home just how important cash is to a small business. Startups won’t get credit with suppliers but will have to wait for (sometimes) months to get paid by customers. How do you survive in the meantime? No cash means no staff, no internet, no phones, no parts, no products. Until you can afford a full time CFO, managing cash is one of the most important tasks the CEO has to deal with. How much cash you have left is often referred to as your runway. Many startups burn cash fast to develop products fast to get into the market fast. But the cash investment has to be burnt against a development plan. And plans have a nasty habit of going awry.
Try to get as much stuff free as possible. In the early days of a startup use other people’s offices, internet, electricity. Find friends and family who will give you any resources without charge. Take your ‘old’ laptop from your previous employer, if they’ll let you. Get potential employees to give some time free of charge. Only when you have some traction with investors or customers should you be looking to sign leases, buy equipment or hire staff. When a colleague and I left to start our first business, I asked the CEO of the company we both worked for, if I could take my computer with me. He replied, “That’s not what I’m worried about, it’s all the stuff Gary is taking!”. Gary had filled his car with an array of equipment that we might find useful. And he got away with it. It’s always worth asking. The worst case is that you’ll be told, NO.
Getting investors to cough-up the cash is one of the hardest problems facing startups. Whilst it is true that there is plenty of money ‘out there’, identifying where, who and how to get at it is hard. Pulling together the first few thousand actually isn’t that difficult. Your own savings plus the friends, family and fools you initially convince to part with a few hundred will get you started. But it won’t last long. My first company actually managed to get a bank to approve an overdraft of £7,000, but only after we deposited another £7,000, and handed over the deeds to my apartment. But this seed money, coupled with all the kit we acquired from our previous employer, was enough to bootstrap us. Our timing was just right. Working with intermediaries, such as incubators, accelerators, or innovation centres, can sometimes give you access to government grants and seed investment. Search out what type of business your local area is trying to attract and see if you can write a suitable proposal. Business Angels are also a good source of funding, and what is known as ‘smart money’: the cash comes with a seasoned entrepreneur who will act as coach and mentor to the CEO. Being introduced is the best way to open a conversation with an Angel. If you don’t know one, find someone in your network who does, convince them your idea is worthwhile and get them to make an introduction.
Pricing is one of the hardest things to get right. Everyone knows there is a sweet spot price for every product or service. But finding that sweet spot is incredibly difficult. The old cost-plus model has not been valid for years (see Mark up below). Value pricing is the only way to look at it. How much do your potential customers value your solution to their problem? If this value is less than it costs to make the product, you don’t have a business. That’s why business modelling is so important before you commit to anything. A business model tells you (and your investors) how you are going to make money. Jacking up the price just because you need to make the spreadsheet show a profit is never the way to go.
In the old days of ‘cost-plus’, marking up was the way to price your product. What margin did you need to cover your overheads? What profit did you need to reinvest in new products? How much did the investors expect to make? Add all this up and add it to the basic cost to reach the price. With value pricing, marking up is simply not good enough. You have to come at it from the other end; how much is the customer prepared to pay for your product (what is it worth to them)? This is then the price, set by the market. If your product, overhead, reinvestment and profit can all be covered by this price, you are in business. If not, you need to rethink what you’re doing. Why, for example, do people pay thousands of dollars for a watch that simply tells the time the same way as a $5 one? For some people, the value is simply being seen with such an expensive item. It projects an image they want, to them the price is worth paying.
Some businesses, some very big businesses have never made a profit – see Uber for more details! However, you are unlikely to start another Uber, and your investors will be looking for your business to make a profit. When a business is sold, the buyer is usually looking to acquire future profits in return for the cost of buying your business. Their rationale is the investment in your business is a quicker way to grow profits than starting from scratch or making other potential investments. Acquisition can also grow the total value of the business. So, making a profit is usually what’s required. You can’t live on investors’ money forever, despite what Uber indicates.
David can be reached at email@example.com