5 Startup Tips to Avoid Cash Crash and Burn Entrepreneurs are an optimistic bunch -- a trait that could cloud your financial judgment. Here are five lessons to keep your business from becoming a cash casualty
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No venture ever succeeds without confident, enthusiastic leadership around a mission that will attract employees, investors and customers. But this rosy outlook can become a liability – especially when dealing with financial projections.
Running out of cash is what ultimately kills eight of 10 businesses within 18 months of opening, according to Bloomberg. Here are lessons to keep your business from becoming a cash casualty.
1. Estimate the amount of time it will take to be profitable -- then double it. This is a key area where optimism does entrepreneurs more harm than good. Five years ago I opened Stone Korean Kitchen, a restaurant in San Francisco. My partners and I all had serious financial chops and experience starting businesses. We put conservative assumptions into our financial models, but we were still nine months off in getting to profitability. That's nearly a year of cash flow we didn't anticipate that we had to cover out of pocket.
Related: How to Anticipate Cash-Flow Problems
2. Hiring must lag behind the need. Ecommerce site Fab.com was once valued at $1 billion. But since that peak, the company has struggled and recently entered another painful round of layoffs as it cut its staff down significantly.
Same thing happened with humor-site Cheeseburger Network, of LOLCat meme fame. After it raised $30 million in venture cash in 2011, it had to lay off one third of their staff last year. This story is repeated time and again. "How did you think I felt? Shitty obviously," founder of Berlin startup Glossybox told VentureVillage after it shuttered offices in seven countries.
Startups must stretch the capabilities of employees to the point of pain. That hurt then dictates where money should be prioritized with more hires. Believe me, the pain of layoffs hurts more than stretching the ability of your workforce. Growth should lead investment, not vice versa. The exception is when you have signals that you're winning in your market and it's time to double-down on hiring to grow. Then it's time to play to win -- but not a moment before.
3. Mind-meld with your CFO. While founders like to chase "shiny objects," a gifted financial captain can help steer a course toward that goal or administer a needed dose of reality.
The key here is a relationship where the founder and the financial officer can finish one another's sentences. Being lockstep with your head of finance helps make sure there is the right alignment around risk vs. rewards.
4. Build a war chest. Just like you should have a personal emergency fund to run your home for at least six months without income, startups need to build a war chest of funds -- be it cash, venture capital or lines of credit -- to cover shortfalls. (And the best time to think about raising money is often when times are good, and you don't necessarily need it -- because when you need it, it's often not around.)
The economy could sour, the business may need to take a hard left turn, or you may need to make a market winning investment with a short -ime frame. Your war chest gives you freedom to maneuver.
5. Don't be penny-wise, pound foolish. Bootstrapped businesses are great at growing lean. Yet the flipside is being consumed by worries about being cost effective rather than spending cash on things that will lead to topline growth.
Understanding the time horizon of an opportunity can be a little like reading tea leaves, but it's important to know if you have a great opportunity in the market but a small time horizon before another competitor gets there. The risk of overplaying your buildup could be worth the reward of owning that space.