Nothing kills a startup faster than running out of money. And nothing can be more paralyzing to an entrepreneur than realizing the business bank account is plummeting toward empty without a plan, or enough time to stop the freefall.
Why does this happen to startups? It usually comes down to one of three familiar phrases
1. “I didn’t see it coming.”
A solid financial model is absolutely mission critical for a startup. The problem is, financial modeling is not fun for most of us — it’s a chore. I admit, I hated accounting in school. I got all knotted up in the “credit this” and “debit that” and invariably, the balance sheet never balanced. It wasn’t until I was running a startup that I fully appreciated this fact. After a few cash flow scares, I learned the hard way that leaning on a tight forecast was the only way to really know where the business was heading. Very few entrepreneurs enjoy grinding on financial spreadsheets, but it’s truly essential if you ever hope to “see it coming” early enough to create a viable plan B before it’s too late.
2. “I’ll just ask my investors for more money.”
Presuming any investor will automatically re-up with more money when you get into cash trouble is a dangerous assumption to make. While investors may have ample cash available, they won’t blindly fund a shortfall, especially when it comes as a last-minute surprise. It is critical to keep them in the loop so you know their appetite for supporting you when things go wrong. If you end up needing to find new money, it will take time — more time than most startups have before cash runs out. And remember, the general rule is, “The more desperate the situation, the worse the deal terms.”
3. “We were on the verge of things turning around.”
A really good sales call. A conversation with an “interested” strategic partner. A new product feature release. These are very promising events that can lift an entrepreneur’s spirits. But promising events guarantee nothing. They are only real when they are in the bank — literally. And while I respect resiliency and a positive attitude, there must be a healthy dose of skepticism to provide balance. Otherwise, banking on good fortune when the money is running out is not going to end well.
It’s cliché, but the best approach when it comes to cash management is simply to plan for the worst and hope for the best. It may be tedious, but the right approach is to grind out detailed, monthly financial projections and stress test (some would say torture-test) them rigorously. It’s how you construct a business plan that can withstand the often inevitable, and always unwelcome, “rising expenses vs. lagging sales” phenomenon that comes with chasing rapid market traction.
Nobody likes to admit how often cash flow problems derail startups — but it happens all the time. And if you can see it coming, you (and your investors) will have time to do something about it.
This post originally appeared in Smart Business Online on May 28, 2019.