Danger Ahead for Post Seed Stage Companies
By Doug Zeisel, TCV Growth Partner-
As reported in the Wall Street Journal (July 21 front page - Early Money Shrinks for Youngest Startups) in Q2 of this year there has been a 22% decline in series A and B funding. Why this happening is and what should you do?
The root cause (our opinion) is the recent volatility of prices of publicly traded companies. Investors in these companies are often insiders and wealthy investors who are seeing their paper wealth shrink and are growing leery of investing more in the VC’s, PEG’s and Family Offices that fund these Series A and B rounds. Hopefully the stock market will stabilize soon and confidence will return. But can post seed stage companies count on that?
Our advice is to ratchet down on expenses as much as possible in order to survive the funding drought that may get much worse. Cut back on expansion plans and make your dry powder last. This will do two things. First, it will keep the company alive longer if it takes more time to get that Series A or B round you have been hoping for. Second, it will show potential Series A or B investors that you have financial discipline. And never count your eggs before they are hatched!
We have seen post seed stage companies nearly spend themselves out of business simply because the Founder/CEO was so confident that expected funding would roll in like manna from heaven. In one case the CEO hired an executive assistant, had an excess of developers, rented space that was for expansion based on projections that were put together to support the case for that series A round. When we came on the scene we soon found that the company did not have enough cash to pay the next month's rent!
Whoa – Don’t put the cart before the horse. Some simple things the founders can do to ensure survival if the next round takes longer than expected (or doesn’t happen).
First – please realize that projections are not a budget. Projections for getting that next round of financing always show greatly ramped up sales (hockey stick) based on marketing and sales team expansion that rely on that next round. A budget should show what the company will spend by month over the next 3, 6 up to 12 months in various expense categories with sales at a sustainable level. Hopefully you can trim your expenses enough to at least get close to your cash flow breakeven point (hopefully you have made the calculation). Developing a worst case scenario budget requires a lot of tough decisions – Do you put off buying that new Tesla for making sales calls or roar full steam ahead? (Just kidding, although there are cases of some startups that burn cash on stupid stuff like there’s no tomorrow). Do you hire that sales manager so you can stop selling so you can focus on other issues? Should you increase your advertising budget? How about that extra space you were going to rent so you could have a workout room for employees? The point here is that until you get that next round of funding, you will need to extend your cash runway as long as possible. Which brings me to another essential factor – cash flow management.
Managing cash flow is not the same as budgeting or forecasting profit and loss. Here’s why – When you make a sale, the sale becomes a “receivable”. On your P&L statement it shows up as “revenue” and makes your company look more profitable. But the truth is that from a financial health standpoint, that profit is just on paper. You have to collect the money owed which may take 60 days from the invoice date. In the meantime, you are paying employees who generated the sale, vendors from who you purchased products or services and the rent, insurance and other expenses. Some companies can be profitable and grow out of business simply because they don't manage cash well (there are many other factors that can lead to failure also).
Cash management flow requires a reasonable forecast, not just a look at your checking account balance (as I have seen some executives do). Forecasting cash flow requires knowledge of your customer’s payment habits, the expected payments you need to make to keep vendors happy, employee expense and rent paid on time. Usually a multi tab spreadsheet is used to forecast cash flow with a summary tab that shows major line items of cash coming in and cash going out with a resulting cash balance at the end of each forecast period. Once created, this spreadsheet should be updated weekly to reflect the impact of recent transactions (invoices and payments as well as other factors). Learn more about cash flow forecasting HERE.
Other aspects of managing cash flow include managing collections and payables, inventory control and timing of capital goods. All of this requires good communication which is discussed in this TCV blog post .
We at TCV are not economists, but what we have gleaned from recent economic and financial publication is that the next 6 to 12 months will be quite volatile which may result in a slowdown of series A and B funding because when investors get nervous they tend to hold onto their cash to reduce risk and be able to take advantage of bargains. This means that it may take longer to get that next round and it also means that valuations are likely to go down somewhat. Will growth at any cost continue to be the mantra? Maybe, but wise founders and CEO’s will prepare for the worst and manage cash carefully.