Ever wonder why some entrepreneurs get capital over and over while others struggle to raise even once?
Successful Serial Entrepreneurs Know How to Grow a Business Without Going Out of Business
Successful serial entrepreneurs know the value of understanding their financials and how to not run out of money. Some of them even have a story from their first business where things didn’t go very well, largely because they didn’t have a clear grasp of the financial information. They often talk about how for the next business they’re not going to let that happen, they’re going to make sure they have a solid understanding and clear plan for their financials from the beginning.
Investors love serial entrepreneurs because they have a clear understanding of what needs to happen strategically and they know how to grow a business. They’ve been there, and they’ve done that. Many serial entrepreneurs (even before they have an accountant) will come and talk to me about building out a solid financial footing for their business.
Starting Your Startup Business With a Strong Financial Foundation
So why is starting out on a good financial foot so important? Because you can’t build a solid financial understanding of your business if you don’t have the data. I will typically start talking to business owners fairly early on (sometimes weeks, sometimes a few months) after they start a fundraising process. They are in a bit of a panic during this time because investors are saying that they need to improve their accounting information. They want them to provide a P&L and balance sheet, and they would like to see some sort of a forecast.
An entrepreneur typically thinks “okay, if I get an accountant and it takes him 20 hours to fix my books, they can be fixed in a week or two.” This is not the case, building good financial rigor and having a clear understanding of what is going on in your business can take time. And time is something you don’t have a lot of in the middle of preparing to fundraise.
If you are currently using a simplified system for accounting like Bench or FreshBooks you may need to change accounting systems—which can take 4-8 weeks depending on the quality of data in your prior accounting system. These simplified systems can help you file taxes, but having true information that you can build a projection off of and present to investors won’t be so easy to get from those accounting systems. And it can be very time-consuming to categorize and clean up financial data from 1 to 2 years of data.
This is why getting it right the first time matters. If you set up the right systems to scale in the first place, you won’t have costly and time-consuming clean-up work at crunch time. It’s important to get the processes right as you’re setting up your accounting system, not just using the standard one a CPA gives you. A little work early on can save you a huge headache later.
Not only will you be saving yourself an accounting headache, but over months of working with a financial professional who is focused on operating finances, you can go through the exercise of thinking through your business model over and over again. Repetition is how we learn. If you wanted to bake a cake for your wedding, you wouldn’t make the first cake in your life the day before the event. For building a financial forecast, your first forecast shouldn’t be built the week before your big pitch. You may not have revenue or many expenses at the beginning of your business to organize, but through building good accounting systems and stretching your strategic muscles by building your business model and testing it, you build a foundation for financial success (or investability) in the future.
Using a Financial Partner When Growing Your Startup
A financial partner can help you think through the implications of the various business models that you’re contemplating before you spend money on any of them. They can help point you in the direction of business models that, while slightly different, may achieve the same results and have substantially different cash flow implications. Meaning you could run into a situation where one business model could require raising $10 million to grow, and another could only require $2 million to get to the same revenue target. Think about how much less dilution that is! If you can get to a stable, reliable proof of concept sooner, fundraising will be easier and the terms will be significantly more beneficial to founders.
Not to mention the dreaded investor meetings. It’s all fun and innovative ideas and thinking about the future until somebody asks you to put numbers to paper and hit growth targets.
A Lesson in Running Your Business’s Numbers
I remember in college I wrote a senior thesis as a requirement of my undergrad major. The professor that I worked with was in the business school and he read my thesis a couple of weeks before it was due to give me some review and feedback. He said he’d give me an A- if I turned it in as is. He thought it was an interesting and well-written piece that used a lot of good research, but was missing a very important component.
In order to get my A- to an A+, he essentially wanted me to build a financial model to show how viable my proposed change to the waste management/compost industry was. I’ll admit, I was a little annoyed! It was my senior year of college, I had two weeks before graduation, and I already had a job lined up in New York. The last thing I wanted to do was more work for a thesis I thought was already done. But I was a little bit of a perfectionist, and he made a great point. It really isn’t a complete business case if you don’t do the math. Your recommendations are all fine and great, but if the numbers don’t work, the proposal you’ve put forward can never work.
As you’d probably guess, I did end up running the numbers. It didn’t actually take me that long, just a few hours. I had already done a lot of the research so I just needed to pull the numbers together in a quick spreadsheet. I did have a business major and I had already done a summer internship in investment banking so I knew how to pull together a quick spreadsheet.
And the conclusion was bad. What I proposed as a brilliant solution for waste management made no sense economically. It was frustrating to spend an entire semester building up a proposal (though the research was kind of fun) that just wouldn’t work.
The good news was this wasn’t my pitch to start a business. I wasn’t planning to raise startup funds to go and build what I had proposed. It was a lesson to me that just because you have a really great and much-needed idea doesn’t mean society is willing or ready to support it financially.
The Right Business Model for a Successful Startup Company
There are many startups that failed because they failed to execute, or at least that’s what they say. But at the end of the day, the real reason businesses fail is because their business models just don’t work or they didn’t plan for a long enough startup runway (i.e. they ran out of cash). Maybe they don’t work fast enough or they require too big of an audience or too much inventory or too much seed capital. And because of that, they aren’t able to grow the revenue quickly enough to cover the costs.
Think how much capital Facebook had to raise before they ever truly became profitable. They had a huge network effect, and that is one of the base components of venture capital companies. They are giving funding to ideas that require scale to be effective and profitable. They aren’t tolerating losses because they love the idea, they’re tolerating losses on some businesses, hope others will take an idea and turn it into a business reality rapidly. But they aren’t willing to take a gamble on any idea that couldn’t return their entire fund (think unicorns). And a large part of being able to take a business from nothing to something huge is to have a business model that works (makes money!) at scale.
Podcast recommendation: There’s a great podcast on the era of millennial life subsidies if you want to give it a listen.
Avoid Costly Financial Mistakes for Your Business
My biggest suggestion to startup and small business founders is this: Build up your financial acumen early. Make some of the biggest financial mistakes of your business on paper, not by throwing money and time at it.
Yes, startups are meant to pivot and try new things and be bold. But there are a lot of business models that are doomed to fail no matter how well they were executed.
Here’s a simple example. Let’s say you own and operate a workout studio that costs you $10,000 a month to operate. But even at full capacity, the maximum amount of revenue you can make from classes and other amenities you offer is $11,000. Spoiler: This business is in trouble before it even starts. A 10% margin is great, but it requires a perfect situation. It requires that you have full capacity all the time, if you were to look at the statistics for your industry I imagine you would find that most workout studios are usually at 80-90% capacity even when they’re doing really well. This leaves you with negative cash flow month after month after month. You cannot scale your way out of an operating model that costs more to operate than it can generate in income.
What Makes for a Good Business Model?
Good Business Model: An operating business that can consistently generate more income than its cost of ongoing operations.
For many startups the revenue for their business model isn’t expected until three or four years into the business. They are going to invest in the future revenue and profit now. And they have raised money to grow the business to a scale where it can generate enough income to cover its operations. I’m not saying a business has to be able to cover its operating costs with its income from the very beginning, but a good business model is one where once the business has achieved a reasonable scale (with a market share less than the size of the entire US population would be good!), the business model works because it can produce a profit.